This is an excerpt from Monday’s (2/8) Point of Sale retail supply chain newsletter sponsored by ArcBest.
Peloton (NASDAQ: PTON) reported stellar earnings last week, growing sales 128% sequentially to surpass more than $1 billion for the first time. Peloton turned a profit for the third consecutive quarter, reporting net income of $63.6 million, compared with a loss of $55.4 million a year ago. Why then did the stock sell off ~8%?
Because Peloton’s supply chain is broken, its customers are pissed, and it thinks $100 million will remedy the situation.
CEO John Foley announced on the earnings call the company would invest $100 million to speed up delivery for its connected products, acknowledging continued problems with delivery delays that are stretching into months rather than weeks
Part of that $100 million investment will go towards the use of air cargo, rather than ocean freight to move products from its Asian manufacturing facilities, mainly in Taiwan, to the US. This… will not be cheap. And if we’re being technical about this, temporarily paying elevated air cargo rates is not exactly ‘investing in the supply chain’, it’s just burning cash.
“On average, in the coming months, we will be incurring a transportation and delivery cost that is over 10 times our usual cost per Bike and Tread, including, in many cases, shipping them by air instead of by sea. We are making this investment because we are as frustrated as you are that you don’t have your Peloton Bike or Tread yet,” Foley wrote.
Both Foley and would-be customers are frustrated over the same thing: value.
Foley and PTON understand the brand they have built and know the value of each customer lost is enormous. Besides Apple and automotive companies, no other brand has a comparable customer lifetime value (LTV) to Peloton. The company estimates its LTV to be $3,500/customer, but that is solely based on content subscriptions and is severely understated because Peloton customers, like Apple users, are likely to upgrade their hardware over the years. Foley also understands the window for locking in customers is rapidly closing. The pandemic has supercharged the company’s business by making home-based workouts almost the only option for the fitness-obsessed, but the (rapidly accelerating) vaccine rollout will eventually lead to gyms reopening and may dent some of Peloton’s newfound appeal.
Peloton hasn’t sat idle through these supply chain disruptions. In December, the company shelled out $420 million to acquire commercial fitness-equipment provider Precor Inc., which will give the company US manufacturing capacity. Peloton said Thursday that even without Precor, it has six times more capacity than it did a year ago and is producing more bikes on a monthly basis than it did in all of 2018.
Peloton also announced it would reduce its marketing spend and is in the process of doubling its customer service team to deal with the influx of complaints. All of these efforts are not nearly enough to match the surging demand for its products.
Customers are frustrated because they feel the price of the product should warrant more transparency and better service. It’s not like Americans haven’t gotten accustomed to shortages at stores, or haven’t had packages delayed this year. It’s that these bikes cost $2,500+, the company continues to take orders and present delivery dates it knows it can’t meet, plays the blame game when the inevitable occurs, and is taking payments before delivery!
Indeed, in many cases, customers begin making payments on their bike through buy-now-pay-later provider, Affirm, weeks or in some cases months before delivery. The surge in orders and delayed shipments have left Peloton with a pile of customers’ cash.
Customers who pay in advance for Peloton products are effectively financing the company’s supply chain efforts. For Peloton, it’s an ingenious accounting strategy that allows the company to leverage customers’ desire to be a part of the brand to expand the company’s ability to meet that desire.
Peloton expects these issues to recede toward the middle of year and for normal delivery times to return by the end of June. It also expects its domestic manufacturing facilities to be producing Peloton products by year-end.
Some notable investors don’t see the supply chain disruptions as much of an issue.
Puru Saxena, a money manager and growth investor, believes Peloton’s inability to meet sky-high demand is a compliment, not a problem. While I agree with him that it is a compliment, I believe he misunderstands the importance of locking in customers RIGHT NOW.
Foley and Peloton do not agree with Saxena; they wouldn’t be spending $100 million and utilizing highly inefficient air transportation if they did. Air cargo is not a long-term solution for shipping 140 lb bikes or 450 lb treadmills, but the company’s usage indicates how big the problem is.
The pandemic fueled unprecedented demand for at-home exercise equipment, but the vaccines bring with them the promise of an end to this pandemic and a return to normalcy. Normalcy means gyms open at full capacity with the full lineup of classes and no masks. The window of being the only option in town is closing for Peloton not only because gyms will reopen in 2021, but also because competition has quickly risen to meet demand.
BMO analyst Simeon Siegel said Peloton could see an end to its ability to thrive amid such logistics turmoil. “Before Covid, there were no large competitors that were largely funded, now there are more rivals that have raised meaningful amounts of capital,” he said.
Peloton is riding a wave for the history books right now. It has grown revenues by triple digits year-over-year for three consecutive quarters while building one of the most recognizable brands in not just fitness, but all consumer segments. If it should continue this meteoric rise, it must sort its supply chain issues before either the vaccines or competition prematurely puts out its flame. To do so, Peloton ought to seek more domestic or nearshore manufacturers, like the Precor acquisition. The elevated air cargo rates are a necessary evil to avoid port congestion, but it should not be confused with investment. It should also consider new relationships with 3PLs that can combine warehousing and e-comm fulfillment so it can take on more inventory stateside but manage it intelligently.
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