Peloton (NASDAQ: PTON) has been experimenting with price changes over the last year. Sales for its exercise equipment and subscriptions surged at the pandemic's onset when gyms were forced to shut their doors, and people looked for in-home exercise options. Its products were flying off the shelf with little need for advertising as the company could hardly keep up with demand and built up a monthslong backlog.
But the narrative has changed since economies started reopening. Sales growth decelerated dramatically, even with a significant boost in Peloton's marketing efforts. Management tried cutting prices to boost demand, but that mostly backfired as it reduced profit margins and sales hardly increased. The market has responded to the company's deteriorating prospects, driving its shares down more than 85% from their peak.
Investing in growth that never materialized
Peloton's business first got into trouble when management optimistically responded to the surge in demand it saw during the initial phases of the pandemic. The company believed the fast-growing interest from consumers would extend beyond the pandemic, and it invested aggressively in increasing its manufacturing capacity. That effort included its $420 million acquisition of Precor in 2021 and plans to invest another $400 million in building out a manufacturing facility in Ohio.
The investments would have been acceptable had revenue continued to rise. After all, sales had been doubling consistently on an annual basis, even before COVID-19. Unfortunately, this pace of growth proved to be unsustainable as gyms reopened, demand fell off, and Peloton was left with significantly higher operating expenses.
Suddenly, Peloton had to work quickly to find a pricing structure that reflected its much higher fixed cost base. At first, management cut prices on its exercise equipment, which did not work well. Then, the company added hundreds of dollars for delivery and setup. Most recently, it lowered the price of exercise equipment in the U.S. by hundreds of dollars and simultaneously increased the monthly subscription fee for existing customers by $5 per month.
This is the first time Peloton has raised subscription fees for existing customers. The company has historically reported a low churn rate. If customers pay over $1,500 to purchase a Bike or Tread, they're likely to keep the connected fitness subscription that costs $39 per month (now $44). If churn rates hold steady, the extra $5 per month should flow right to the bottom line, and importantly, this latest move will not depend entirely on increasing sales to increase profit margins.
A few months earlier, Peloton had announced significant changes to its cost structure, including layoffs and a reduced manufacturing capacity that management expects will save $800 million annually once fully implemented. Together with the price increase on subscriptions for existing members, it should put the company on a more sustainable footing.
Don't go buying Peloton stock just yet
The company appears to be moving in the right direction with these latest changes. However, investors would be prudent to wait to see tangible results before jumping in. Put Peloton on your watch list and see how the company fares over the next few quarters under new CEO Barry McCarthy.
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