This is an excerpt from Friday’s (5/7) Point of Sale retail supply chain newsletter sponsored by ArcBest.
What happened? More than two weeks after declining the Consumer Product Safety Commission’s request to recall its treadmills, Peloton announced Wednesday the company is voluntarily recalling all its Tread and Tread+ units in the U.S. The announcement marked a major reversal of Peloton’s initial reaction and comes after more than 38 reports of injuries involving Tread+ machines, including one fatally injured child, according to the CPSC.
While Peloton doesn’t break out sales of its treadmills, research firm Cowen had previously estimated that the Tread+ would represent about 2.2% of unit sales in 2021. That’s out of about 1.63 million stationary bikes and treadmills combined, it said. According to Peloton, the lower-priced ($2,450) Tread machine was set for U.S. launch later this month, and was only available through limited invite-only release. The company states only 1,050 Tread units have been sold in the U.S.
What are customers’ options? The two machines are being recalled for two completely different reasons, and therefore have different proposed remedies. The larger, more expensive ($4,250) Tread+ is being recalled after dozens of reported injuries and incidents involving pets, children or other small items being “sucked under” the elevated running surface. The CPSC said Peloton’s treadmills are designed differently than those of competitors, with “an unusual belt design that uses individual rigid rubberized slats or treads that are interlocked and ride on a rail,” which leaves room for stuff to squeeze in.
The newer Tread model is being recalled due to a faulty mount on the touchsceen. The CPSC has received 18 reports about the touchscreen loosening and six reports of the touchscreen detaching and falling from the Tread.
Tread+
Refund: Peloton has given an exceptionally long period of time for users to decide whether or not they’d like to return their Tread+. Users have until November 2022 to receive a full refund, and units returned after will receive prorated refunds.
Relocate: Peloton is offering free relocation to another room in users’ homes where children and pets cannot access it.
Regardless of whether users choose to refund or relocate, Peloton is working on software upgrades on all Tread+ that will add safety features such as auto-lock after use and passcodes prior to usage.
Tread
Refund: Peloton gave no specific timeline like the Tread+ but is offering a full refund to any Tread owners.
Repair: Peloton is working with the CPSC to develop a repair for the Tread touchscreen console and hopes the CPSC-approved repair will be available in the coming weeks.
What’s the impact on Peloton? The explicit cost incurred from this recall is far less than the potential damage to Peloton’s image. To start, treadmills make up an insignificant portion of Peloton’s unit sales at just 2.2% in 2021, according to Cowen estimates. Peloton users are passionate and vehemently loyal to the brand. In the reply sections of the company’s social media channels, you’ll find countless strident bikers battling every negative comment. The Peloton Community subreddit, which has no affiliation with the company, boasts 193,000 members.
After burning an hour feeling out the general sentiment on r/pelotoncycle, I don’t feel a meaningful portion of Tread+ or Tread owners will request a full refund. At least not because they feel unsafe or are unsatisfied with the product. That said, there is something Peloton needs to monitor and possibly plan around: users wearing their units out for the next 18 months and requesting a refund or new unit near the November 2022 deadline. Peloton and the CPSC have given an extraordinarily long time for people to decide whether they’d like a refund, and I believe some people will misuse it.
Most of the current issues that have forced Peloton to recall the Tread+ can likely be solved with minor software upgrades, but the company is working on a hardware fix as well. A passcode to initiate and auto-lock at the end of a run keeps the machine from endangering pets and children when it is not in use. Peloton said the upgrade should be available within the coming weeks.
On the company’s earnings call Thursday, CEO John Foley said, “There will probably be a change in the manufacturing” of the Tread+, but he’s optimistic there will be no manufacturing change to the Tread, which is expected to be a higher-volume product next year.
For the Tread, the remedy is a bit more complex and will require a trained specialist to inspect the unit and potentially repair the touchscreen mount. Luckily, the recall occurred before the widespread launch of the Tread in the U.S., and Peloton has only delivered 1,050 units. But the company has been forced to delay the U.S. Tread launch, which is expected to be a massive subscriber growth driver this year. Bank of America analysts Justin Post and Joanna Zhao downgraded PTON from Buy to Neutral and slashed their price outlook from $150 to $100 Wednesday, citing the delayed Tread launch as the biggest concern. The analysts estimated 600,000 new Tread sales this fiscal year prior to the recall.
During the earnings call Thursday, CFO Jill Woodworth revised next quarter’s revenue estimates down from more than $1 billion to $915 million, but stated PTON is still on track for more than $4 billion in revenue for FY2021.
What’s all this cost? It’s nearly impossible to get a solid estimate on costs without an idea of how many Tread+ owners will opt for a refund, but given Peloton’s 92% customer retention rate, I suspect not many people will be giving up their unit. In the earnings call Thursday, Woodworth estimated a $165 million revenue hit over the next three months from the recall. Two-thirds of that total stems from the ceasing of Tread/+ sales in the U.S., and Peloton estimates an increase of $50 million to its return reserves from user refunds.
Meaning, Peloton expects to incur roughly $50 million in refund expenses alone, not including logistics costs. Asked what percentage of users this equates to, Woodworth noted it is an extremely difficult thing to project, but using all the available data, she estimates “roughly 10% of Tread and Tread+ out there” will request refunds. Woodworth noted the company, as a part of the recall, “will incur logistics costs to pick up returned Treads and Tread+.”
There’s a ton of nuance here that’s fascinating for supply chain nerds like ourselves. Ideally, Peloton would seek to orchestrate returns with deliveries in the area. By far, the cheapest way for Peloton to remove a treadmill would be to inject the return into a route that’s already running. This is a complex problem, but I believe one of the reasons Peloton has given such a long return time window is so it can build up as many possible deliveries and as much density near a return as possible. Pairing with even one delivery in the area drastically reduces the reverse logistics costs. The delivery people, often XPO or J.B. Hunt if not completed by Peloton employees, have already been trained on assembly and have the equipment necessary to handle the return.
Where the machine heads from there adds further complexities. The cheapest and most efficient from a time standpoint would be to haul that bad boy straight to the landfill. Bill Catania, founder and CEO of final-mile orchestration platform OneRail, estimates a cost of $250-$500 per pickup and immediate disposal, with an estimated mileage of 25 miles each direction. This would be the cheapest and fastest way for Peloton to put this behind them, but it would be a wasted opportunity.
In April, Lululemon was the latest in a string of apparel and consumer brands to launch its own resale program in which customers resell used items to the brand and the brand refurbishes for resale. It’s a huge movement that is sweeping the retail industry as brands seek to become more sustainable. For highly discretionary brands, like Lulu or Patagonia, whose products hold value longer than most, it will be a significant revenue driver into the future.
You know where I’m going with this, right? I can’t think of another consumer company, besides automotive brands — maybe and probably only Tesla — that could create a more valuable certified pre-owned market than Peloton. In an earnings call last year, CEO John Foley said the company had plans for a CPO program “in the coming years.” Well, John, here’s your chance. These machines hold serious value. Surprisingly, I couldn’t find a single Peloton Tread+ on eBay, but there are ~100 bikes, which retail for $1,895, posted at $1,500-plus.
I spoke with a number of last-mile and reverse logistics providers to get a better understanding of the cost dynamics between the different remedies Peloton is offering. Prior to his role at Suddath Global Logistics, Andrew Lockwood spent more than five years building final-mile networks with retailers at Kenco. While he was there, a very large, multinational consumer electronics company wanted to implement a free replacement service of large appliances anytime one faulted. Armed with this experience, Lockwood estimates a minimum charge of $200-$225 per pickup stop. Depending on where the unit goes from there, costs can multiply. If Peloton were to take my advice on the CPO program, it would be sending those units back to a central location for inspection, repair and resale prep. To make that happen, units would be taken from home to a warehouse/DC where the machine would be boxed and palletized for an LTL carrier to pick up.
In all, Lockwood estimates the cost to pick up the return, box and prep, and LTL charges to total $500-$700, depending on a number of factors including distance traveled, complexity of pickup, and whether it’s a “hotshot,” one-off run or if it fits into an existing route. However, Peloton has grown its proprietary fleet of delivery vans rapidly as it attempts to crowd out its white-glove partners to own the full customer experience. The delivery team has grown from 900 in 2019 to over 2,200 currently, and Peloton now has more than 700 delivery vans across the U.S.
So, given Peloton’s strong logistics growth, it will likely be able to handle many of the returns itself, especially in the major metro areas where its delivery fleets are mostly situated. It helps that Peloton’s user base, for many reasons, is also mostly situated in major metro areas. For rural users, or those located in small metro areas, Peloton will need to seek third-party services to conduct pickups. Fortunately for Peloton, the company has rapidly grown its last-mile hubs and warehouse locations to 47, meaning Peloton has many options to route returned units, which should lower logistics expenses.
Also, given the growth in its delivery network, I feel Peloton will be capable of completing many of the Tread+ relocation requests itself, further lessening the recall impact. Again, for rural customers and those in small cities, Peloton will seek out third parties for help. My suggestion is to avoid final-mile providers and opt for moving companies. Movers know the tricks of the trade for moving heavy/bulky stuff through homes, and there are thousands of providers to request bids from. Fast-growing moving startup Bellhop quoted me $189 an hour for a Peloton treadmill relocation, but that rate varies by geography.
Woodworth stated that these relocation costs, combined with the increase in return reserve, are expected to reduce Peloton’s Connected Fitness product gross margin this quarter by approximately 900 basis points.
Final thoughts. Peloton made a mistake by not working earlier and more closely with the CPSC, and Foley admitted to that mistake multiple times in Thursday’s call. “We should have been more open to a productive dialogue with them from the outset,” Foley said. “For that, I apologize.”
Since that mistake, I believe Peloton and Foley have handled this as well as they could have. Whatever your opinion of Professor Scott Galloway, his simple three-step crisis management plan should be standard across industries.
This recall, and an 18-month window to return Tread/+, is a shrewd overcorrection. Peloton is buying customer loyalty with this offering, and it will be beneficial in the long term. The two big developments to monitor over the next six to 12 months will be: 1. How quickly Peloton can get its Tread launch back on track, and 2. What the trend in returns looks like. Foley believes the company could proceed with the launch as early as July, which is earlier than many anticipated.
Woodworth said the company expects to “see a sort of a bigger spike initially” in returns and that the trend “should subside over the next several months.” After my time on r/pelotoncycle, I am afraid she may be mistaken and the opposite will be true. It seems many, many users are interested in the idea of continuing to use their Tread+ (once the software updates are implemented), holding out for more information on a potential hardware enhancement, and eventually taking Peloton up on its overcorrection. Time will tell whether users take advantage of Peloton’s mistake, but the mistake itself isn’t as bad financially as initially feared.
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