AcquiredPeloton - the entire history and strategy behind America's trendiest workout
EVERY SPOKEN WORD
125 min read · 25,384 words- 0:00 – 0:41
Intro
- BGBen Gilbert
Ride to Greatness? [chuckles]
- DRDavid Rosenthal
We're not here to work out, we're here to outwork. [laughing] I said that to Jenny the other day, and she was like: "What are you talking about?" [laughing] Outwork!
- BGBen Gilbert
Just internalize all the Peloton instructor slogans.
- DRDavid Rosenthal
Oh, so great.
- BGBen Gilbert
David, just make sure you live, learn, love well. See you next time. [upbeat music]
- SPSpeaker
Who got the truth? Is it you, is it you, is it you? Who got the truth now? Hm. Is it you, is it you, is it you? Sit me down, say it straight, another story on the way. Who got the truth?
- 0:41 – 3:02
Emergency timing: Peloton’s CEO change and “comeback story” framing
- BGBen Gilbert
Welcome to Season 10, Episode 2 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert, and I'm the co-founder and managing director of Seattle-based Pioneer Square Labs, and our venture fund, PSL Ventures.
- DRDavid Rosenthal
And I'm David Rosenthal, and I am an angel investor based in San Francisco.
- BGBen Gilbert
And we are your hosts. Well, listeners, we have been waiting to do a Peloton episode for a long time, just searching for that, that right moment, you know? We, we didn't do it at the IPO, and then there was the big stock run-up, and we thought about that, and we got a zillion listener requests, and, of course, and, uh, the pandemic hitting, and David and I both becoming customers, and these crazy commercials. And, and, like, somehow none of these ever felt like the right moment. So we figured, w- well, how about this wild, company-changing news we just scramble over 24 hours to prep [chuckles] and have done basically nothing in the last 24 hours except learn everything we possibly can about this company that we are so intimate with already?
- DRDavid Rosenthal
Well, I mean, anytime Barry McCarthy gets involved... Like, we were texting, w- uh, Ben texted me the news, and I was like, "That's it. We gotta do it. Emergency pod." [chuckles] Acquired superhero, Barry McCarthy, literally riding again.
- BGBen Gilbert
Yes.
- DRDavid Rosenthal
Oh, just so excited.
- BGBen Gilbert
And, you know, there's this fun thing, too, of like, I've seen articles that are like, "John Foley's stepping down as CEO." Well, yeah, technically, technically. Th- people are saying he's staying involved. He's staying very involved, and, uh, we'll definitely dive into sorta how this duo is gonna conquer the road ahead together.
- DRDavid Rosenthal
Indeed.
- BGBen Gilbert
Well, first, we wanna say, uh, we're recording this on February 9th, and, uh, that is important because yesterday, uh, February 8th, was the day that the news broke about all of this Peloton stuff. Uh, today, February 9th, was Barry McCarthy's first day in the CEO seat, and I think he frames this better than we ever could've. In his, uh, email to the company this morning, he wrote: "And now that the reset button has been pushed, the challenge ahead of us is this: Do we squander the opportunity in front of us, or do we engineer the great comeback story of the post-COVID era? I am here for the comeback story."
- DRDavid Rosenthal
We are here for the comeback story.
- 3:02 – 7:26
Sponsor + show notes: Vanta on SOC 2, plus housekeeping and disclaimers
- BGBen Gilbert
Indeed. All right, well, we spent the last 24 hours getting, uh, everything in order, all of our thoughts. I've done 167 workouts since January of 2020, when I got my Peloton bike, to make sure we are as knowledgeable as possible. And first, we wanna introduce you to our presenting sponsor, Vanta, the leader in automated security and compliance. Now, as you know from the Taylor Swift episode, we are huge fans of Vanta and their approach to the whole compliance process. They do SOC 2, HIPAA, GDPR, and more, and we've got CEO and co-founder Christina Cacioppo back with us today. So Christina, last time we talked about, a little bit, the origin of SOC 2 and how it's administered. What's the checklist?
- SPSpeaker
One of the interesting things about SOC 2 is, is folks definitely refer to it as having a checklist, but there isn't really one. So if you go to the AICPA website, and you look up the standard itself, it's really high level. Uh, it has things like... w- and written in more complicated, you know, compliance speak, but basically says, you know, "Hey, do you have, you know, systems in place to control how data is accessed in your company?" Right? And then that can be implemented any number of ways. So actually, in the early days of Vanta, when we talked to engineers who knew compliance, or actually when we talked to investors who are engineers, they basically told us, they're like: "How do you automate that?" Right? Like, "That's, that's too high level to be able to, uh, automate," which they're correct. Uh, one of the things we did with Vanta was just break down those high-level statements into specific things that could be automated and a company could implement. Um, this obviously helped us actually build software for a category that never had software before, but it also helps companies, because we realized one of the reasons smaller companies didn't pursue these certifications earlier, even though they helped them grow, was they just didn't have the time, bandwidth, attention to figure out what those things meant.
- BGBen Gilbert
What are the most obvious, no-brainer things that should be a part of that?
- SPSpeaker
So it's really, really high level, a SOC 2 or a compliance certification is trying to figure out if you are kind of running a reasonable organization that protects data, and so you can kinda break it down into three pillars. One is cloud infrastructure. Do you have your AWS, GCP, Heroku, whatever you're using, is it set up reasonably, right? And that can mean one of, you know, hundreds of things, but just, do you lock all your doors and windows? Uh, one is around laptops, [chuckles] like devices employees are using. Uh, you know, are those reasonable? 'Cause they often have customer data on them or access, you know, websites that have all of the customer data. And then the final one is employees themselves, so the accounts they use, their own practices, um, how they're trained and onboarded. Uh, you know, again, that gets broken down, but just three pillars: cloud infrastructure, devices, and employees.
- BGBen Gilbert
... Our thanks to Vanta, the leader in automated security and compliance software. If you are looking to join Vanta's two thousand plus customers to get compliance certified in weeks and instead of months, you can click the link in the show notes or go to vanta.com/acquired for a sweet, sweet ten percent discount. Other things, you all know the drill by now. If you wanna join the Slack, you should: acquired.fm/slack. You should listen to the LP Show to get the nerdier stuff, like our updated thoughts on the markets, and a little bit less us and a little bit more the excellent NZS Capital guys. We talk about all of that and semiconductors in our latest episode. You can search Acquired LP Show in any podcast player, or you can become a member at acquired.fm/lp, uh, if you want those two weeks earlier or to join our LP-only Zoom calls, one of which is tonight, if you are listening the day that this episode comes out. So LPs, excited to see you in there.
- DRDavid Rosenthal
The LP Show has been on fire recently. We've got, like... I'm just so pumped about the guests we're getting and-
- BGBen Gilbert
10K Diver, that was really fun, too. Pseudonymous interview.
- DRDavid Rosenthal
We've got some great founders coming up.
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
It's awesome.
- BGBen Gilbert
Uh, listeners, as you know, this is not investment advice. [chuckles] Uh, very much-
- DRDavid Rosenthal
[laughing]
- BGBen Gilbert
... not investment advice this time.
- DRDavid Rosenthal
It may be product advice, though. I, I've got some- W- I definitely wanna discuss Peloton's product lineup 'cause I have some thoughts.
- BGBen Gilbert
I bet you do.
- DRDavid Rosenthal
But it's not investment advice.
- 7:26 – 9:42
Acknowledging layoffs and why Barry’s “wartime” profile matters
- BGBen Gilbert
I bet you do. Uh, we may have investments in these companies, uh, that we discuss. The show is for entertainment and informational purposes only. And before I hand it over to David for history and facts, we do want to acknowledge that a big part of the news yesterday in the restructuring, uh, is that Peloton laid off twenty-eight hundred people, including twenty percent of their corporate office. And a- as fascinating as it is to dive into this business and the strategy, and of course, some of the drama, this is a super tough day and a super tough week for those twenty-eight hundred people who had a really, really terrible Tuesday reading this news, talking to their managers, all that, and, and our hearts, um, go out to those folks.
- DRDavid Rosenthal
Yeah. Oh, layoffs are [inhales] tough. Have you, uh... W- there, there probably weren't layoffs when you were at Microsoft, were there?
- BGBen Gilbert
Like, two months after I left, there was a-
- DRDavid Rosenthal
Ah
- BGBen Gilbert
... massive round. Yeah.
- DRDavid Rosenthal
Yeah, yeah. There were layoffs at UBS, in my first job out of college, during the financial crisis, and ultimately... Gosh, I think, like, close to fifty percent of the company was laid off while I was there.
- BGBen Gilbert
Wow!
- DRDavid Rosenthal
It's hard. It's so hard. It's- I mean, layoffs are just no fun. They're just [chuckles] ... I mean, that's obvious statement, but it's hard.
- BGBen Gilbert
Yeah. And to transition us in, of thinking about our previous episode with W- well, one of our previous episodes with Barry McCarthy, he was a part of that big sort of like company-changing moment at Netflix, where they had to restructure the whole thing, and I think that also had a huge round of layoffs before they sort of committed to a new, a new plan going forward when Netflix was on the ropes and about to die.
- DRDavid Rosenthal
Yep, forty percent. Forty percent RIF, but-
- BGBen Gilbert
So he's, he's kinda clearly good at, uh, at sort of taking a bare-bones team and, and making the most of it.
- DRDavid Rosenthal
Indeed. Well, with that history and facts, I think that is the perfect transition. Barry McCarthy, the acquired superhero, we talked about him on the Spotify episode. We talked about him on the Netflix two-parter, both parts of the Netflix episodes, because he ended up staying for 12 years at Netflix through all the crazy... Well, cr- that is such an amazing story. Like, going back, reading the transcripts of those episodes,
- 9:42 – 23:32
Barry McCarthy deep dive: from Music Choice to Netflix’s subscription model
- DRDavid Rosenthal
the Netflix journey is amazing. Uh, but we haven't talked about him too, too much since, until today, [chuckles] and I thought, in preparation for today, it would be fun to dive a little more into his background. First off, something that just, like, [chuckles] is wild, he's sixty-eight years old.
- BGBen Gilbert
The spring chicken coming in to, to, turning this thing around.
- DRDavid Rosenthal
It's unbelie- he's the same, you know, roughly the same age as our parents, uh, if not, uh, uh, if not, maybe slightly, slightly older, I think, than yours, right?
- BGBen Gilbert
Definitely older than mine, meaningfully older, about a decade. Um, but yeah, as, as other people ease into retirement, uh, Barry accepts his first ever public company CEO job.
- DRDavid Rosenthal
I know. Oh, amazing. He's like the Sean Connery of tech. Like, he's- [laughing]
- BGBen Gilbert
[chuckles]
- DRDavid Rosenthal
... He is James Bond. Like, he will always be James Bond. So great. Well, a few quick things about his background. There's not a lot on the Internet about or with Barry McCarthy himself. In fact, as far as I could find, and I looked pretty deeply, the only, like, dedicated long-form interview with Barry McCarthy on the Internet is on YouTube, with the headmaster of his high school, that he went to, a school called The Hill School.
- BGBen Gilbert
Is it a boarding school?
- DRDavid Rosenthal
It's a boarding school in the Philadelphia area. Uh, it was when I went to Tower Hill School in Wilmington, Delaware, also in the broader Philadelphia area, and people would always get The Hill School and Tower Hill School confused. We, we had a little chip on our shoulders, but-
- BGBen Gilbert
Your upbringing is somehow, like, related to every episode these days. It's like, are, are we only selecting for people in the southern, southeastern Pennsylvania region? [chuckles]
- DRDavid Rosenthal
Totally, totally, the Mid-Atlantic region. Uh, well, this interview is [chuckles] actually amazing. It's an hour long. We'll link to it in the show notes. As of yesterday, it had, like, a hundred views total on YouTube.
- BGBen Gilbert
Now, it's up to, like, five or six hundred. It's still super small.
- DRDavid Rosenthal
If you do nothing else from this episode, go watch this interview with Barry, and you will get a sense of, you know, this man and his experience.
- BGBen Gilbert
It's also six months ago, so it's, like, very recent. I mean, it- for a very long time, he had basically no public appearances.
- DRDavid Rosenthal
And very, very relevant to this news today, that I was gonna save this for later in the episode, [chuckles] but one of the final questions that the headmaster, who's a wonderful interviewer, asked him is sort of, you know, like: "Well, you know, Barry, are you bored in retirement?" Now that he's retired from Spotify fully at this point. [chuckles] And his answer is, "Yes."... I'd like to think that I have another game in me [chuckles] and how prescient that would prove to be. So we all know that Barry becomes the CFO of Netflix when the company is very, very small, still a startup. I think there were only about forty people at Netflix when he joined, and it was certainly pre-IPO, pre there being a real business there, which we'll get into. But how... You know, this was also not early in Barry's career. How did he end up becoming the CFO of Netflix? Well, he had been the CFO previously to Netflix of another company, actually, a digital music streaming company. [chuckles] Did you know this, Ben?
- BGBen Gilbert
Really? No.
- DRDavid Rosenthal
He was the CFO of a company called Music Choice. Music Choice, do you remember back in, like, the early days of digital cable and satellite TV, there used to be those channels? Like, uh, we had DirecTV growing up. I think they were in, like, the six or seven hundreds.
- BGBen Gilbert
It was sort of like Sirius XM in a way. It was like each one was a genre.
- DRDavid Rosenthal
It was ex- it was exactly like Sirius XM, but just on your cable box or your satellite box. You'd go to XYZ channel, and they'd have some crazy, you know, like, '90s era visualizations. [chuckles]
- BGBen Gilbert
Yes. You know, you still see them in hotel rooms sometimes.
- DRDavid Rosenthal
Totally! That was Music Choice. Barry was the CFO of Music Choice, and what is- like, it's a, it's a cable channel, a couple, like, it's subscription [chuckles] revenue, music streaming, music, right? Like, what... How prescient.
- BGBen Gilbert
Well primed for the ultimate Spotify gig that he would take when he took them public.
- DRDavid Rosenthal
Some other things that I, you know, learned most of this from that interview. Um, how did he end up le- so he had been a management consultant at Booz Allen, I think, early in his career, and then an investment banker for a long time, and it's a well-trodden path from, you know, senior investment banker to going and becoming CFO of, of a company. Music Choice may have been public at that point in time. How did he find his way out to California and Netflix? He got fired [chuckles] as CFO of Music Choice. I don't know if it was part of a RIF and if there were layoffs or if he got fired directly, but he's very open about this.
- BGBen Gilbert
I mean, most RIFs don't include the CFO unless it's performance-based.
- DRDavid Rosenthal
Right. Usually, the CFO is the one, [chuckles] you know, orchestrating the RIF. Um, yeah, he got, he got fired, and he was forty-five years old. He had already had this, you know, sort of long career as an investment banker and then as a CFO, been fired, and, like, what an inspiration to go from that to having so many more chapters to come, even now to a new chapter at sixty-eight years old. Like-
- BGBen Gilbert
Yeah.
- DRDavid Rosenthal
Gosh, I hope my life is that interesting.
- BGBen Gilbert
Label it what you want, growth mindset or learning from your mistakes or anything like that. It does feel like this guy is compounding knowledge.
- DRDavid Rosenthal
And I wonder if also... You know, again, we talked at the top of history and facts about how this was a hard week for so many people at Peloton, and, you know, our hearts are with them, and it's hard, but, yeah, it's like Barry went through this himself.
- BGBen Gilbert
Yep.
- 23:32 – 26:24
Spotify chapter: direct listing innovation and scaling the free/ad business
- DRDavid Rosenthal
Yes. [chuckles] Particularly subscription business, strategic finance. So then, you know, when he retires from Netflix, he goes and joins TCV, which of course, has a storied history of investing in Netflix and helping them through, through all of their challenges as a financing partner.
- BGBen Gilbert
And we should say, TCV stands for Technology Crossover Ventures, which, while it seems like everyone is doing this now, investing in both private and public companies, this... I mean, this was a unique enough strategy when they were formed, that they named themselves after it. I mean, th- that's, that says a lot about how long TCV has been doing that.
- DRDavid Rosenthal
So he joins them as a venture partner, and, uh, I don't know if he was thinking that he was just gonna sort of be on boards and be an advisor for the rest of his career, but in 2014, he joins the Spotify board, and he's sort of so taken by-... both the Spotify business and Daniel Ek and the opportunity ahead, and they need someone like him to really come and transform that business. We should revisit Spotify at some point, because when we covered their direct listing, which he architected [chuckles] Barry, like, invent-- you know, didn't invent, but modernized the direct listing and everything that's happening now.
- BGBen Gilbert
Yes, taking a page out of the Ben & Jerry's playbook.
- DRDavid Rosenthal
[chuckles] Indeed, indeed. So he goes and joins Spotify as CFO, and not just CFO, but also eventually, he would add, uh, add head of their free business, the advertising supported business at Spotify. So not just the subscription business of Spotify.
- BGBen Gilbert
Oh, I didn't realize he's, like, an operational leader of the ad-supported business?
- DRDavid Rosenthal
So originally, he moved to Stockholm and was, uh, was CFO of the business in Stockholm, and then moved to New York to set up and really drive the free portion of the Spotify business-
- BGBen Gilbert
Ah!
- DRDavid Rosenthal
... which is what Taylor was so upset about, and that now they, they've built, built out since he-- when he took that over, they built that into a real business and working with artists and making that actually work for, for the company and for all the stakeholders. Um, so he had this incredible chapter there, the DPO, everything. And then in January of twenty twenty, he retires, presumably fully at this point in time, 'cause he's sixty-six years old [chuckles] and rejoins the board of Spotify and, uh, uh, and spends, you know... Thinking he's gonna go spend the next few years joining boards again. He joins the Instacart board and, uh, re, uh, reestablishes his relationship with TCV.
- BGBen Gilbert
Didn't he also join the board of Pandora, if I'm remembering right? Speaking of music subscriptions.
- DRDavid Rosenthal
That was back before Spotify.
- BGBen Gilbert
Oh, okay. Got it. But, like, d- just to add yet another credibil- a piece of credibility on music-related subscription [chuckles] businesses.
- 26:24 – 32:53
Peloton’s true origin: boutique fitness (SoulCycle/Flywheel) and “on-demand wins”
- DRDavid Rosenthal
Totally. So now let's, let's switch over to the Peloton track of the story here. Peloton, as many folks probably know, was founded in twenty twelve by John Foley, who... And this is where, you know, the connections just go so deep here. [chuckles]
- BGBen Gilbert
David, I think it's inappropriate to start the Peloton story in twenty twelve. I just have to say, I know you're the usually the one who goes back. T- this story starts in two thousand six with SoulCycle, and I think, without going into the whole SoulCycle story... By the way, there are two awesome episodes of How I Built This, one on SoulCycle with the founder, founders there, uh, and then another one actually interviewing John Foley on Peloton, which is great. And this, uh, we don't think about the narrative of Peloton that much th- this way right now, but if you think back to when you first heard about Peloton, it was SoulCycle, but on a screen in your living room, and SoulCycle was this massive, dominant brand if you were touchy-feely, and then there was Flywheel, which if you were more numbers driven, you know, Flywheel was more your shtick. So I guess it was more of a Flywheel than a SoulCycle, but it had the prestige brand of a SoulCycle.
- DRDavid Rosenthal
And I actually don't know the history on this. You may know, but there's, there's very intertwined history with SoulCycle and Flywheel, right?
- BGBen Gilbert
There is. We will get to that and what would have happened otherwise.
- DRDavid Rosenthal
Ah, okay, okay. We'll save it for later. We'll save it for later.
- BGBen Gilbert
It is totally inappropriate to, like, it, be-- think about Peloton in a vacuum. You know, the, the, the moment in two thousand twelve, and I think even twenty eleven, when there was ideation happening, was totally, you know, I'm John Foley, I live in New York, SoulCycle is totally taking off and, and this, you know, not yet connected fitness, but sort of-
- DRDavid Rosenthal
Boutique fitness
- BGBen Gilbert
... high-end group boutique fitness is taking the world by storm. And of course, there's, there's John, who's not really the most, uh, numbers-oriented, schedule-oriented, disciplined person, more a visionary product leader type person, and he's thinking, "You know, I, I, uh, I can't commit to five days from now, making sure that I schedule that spot in SoulCycle. What if I could decide last minute, and there was an infinitely scalable version of SoulCycle, where the room wasn't bound by four walls?"
- DRDavid Rosenthal
Totally. Well, the, we'll get into who John is in a, in a sec, but, uh, I was gonna do this in a second. But y- you're absolutely right. To start with SoulCycle and boutique fitness and Flywheel, uh, and Barry's Bootcamp, and, you know, all the other similar businesses out there. Yeah, so John and his wife, Jill, lived in New York, which is the epicenter [chuckles] of all of this. And, um, and there's so many great, great instructors at these places that have cult followings. People fly from all over the world to come to New York. That's where you wanna be if you are in this, you know, an instructor, an up-and-coming instructor in this, you know, burgeoning sort of new ca- category. And this is what's just brilliant, you know, A, it's so [chuckles] like you said, it's so hard to get spots in those classes. Like, you gotta-- the instant they become available, [chuckles] like, you even had to do this in Seattle, I remember, but, like, in New York, it's impossible.
- BGBen Gilbert
It was a meme to buy the shirts, and the shirts said, "Noon on Monday," because noon on Monday is when you had to stop whatever you were doing and scramble to reserve the spots.
- DRDavid Rosenthal
So anybody, it's hard to get spots with the best instructors [chuckles] in these classes. John and Jill, his, his wife, they were, you know, super into this. They had two little kids. [chuckles] Like, I can't... I know I've got one little kid, like, I can't ima- like, it, it would be... Obviously, we live in a different era now, but even if we didn't, like, there'd be no way I could do this. [chuckles] Like, there were a lot of people out there that were just, uh, wanted this product and, and couldn't get access to it. Um, so the Peloton idea, like, it was, it was revolutionary on a whole bunch of dimensions. You know, one was-... democratizing location. Like, you didn't have to be in New York [chuckles] to get the best stuff. Two was, like you said, elastically scaling access to the best instructors, not the average instructors or the low-quality instructors, like, literally only the best, and infinite class size.
- BGBen Gilbert
And so if you think those two vectors alone, infinite class size and geography agnostic, that's massively TAM expanding. You know, the, theoretically, the TAM for connected fitness should be way bigger than boutique fitness. But then there's even a third layer of icing on the cake, which is time shifting. So what if you can't make it to that 5:00 a.m. class?
- DRDavid Rosenthal
So to feather back and preview a little Barry element here, [inhales] you know, one of the things that he talks about, to the extent he does talk publicly, and learned deeply from Netflix, but has just become kinda ingrained in him, and I think is now an obvious insight, but definitely at Netflix, and at this point in time, when Peloton was getting started, not obvious, is his quote is: "Everything linear dies, everything on demand wins." And it's so true. Like, you know, the being able... This, this element of being able to access best-in-the-world content on your schedule, [chuckles] when you want it, like, that's what makes Netflix awesome. That's what makes Spotify awesome. That's why podcasting is better than talk radio. [chuckles] That's why music streaming is better than listening on the radio. Uh, that's why Netflix is better than linear TV programming.
- BGBen Gilbert
Yeah. Which is mostly true, but not entirely true. You got, like, sports is probably the notable exception.
- DRDavid Rosenthal
Right, and that, uh... Barry always says that, you know, sports is sort of the one. There are a few categories out there. But here is this concept being applied to something, a whole radically new market, like fitness. Who would have thought? Uh, like, it's, it's absolutely brilliant, and, like, we can't give enough credit to Peloton and, and John Foley for innovating on this.
- BGBen Gilbert
In fact, you could even argue Slack is indicative of this trend, work going async instead of synchronous, pulling out of meetings and going to, you know, chat-based or document-based forms of collaboration. That is a, you know, on-demandness of something that was previously linear.
- DRDavid Rosenthal
Totally. [chuckles] Yeah, like how many... People still obviously have, you know, work phone calls and whatnot.
- BGBen Gilbert
The number of Slack conversations that used to be a meeting, or the number of document reviews that used to be a meeting, is just awesome.
- 32:53 – 38:06
John Foley’s background—and the pivotal pivot to vertical integration
- DRDavid Rosenthal
Yep, and to then create a product that is, like, native to that. You know, like, email existed, right? But, like, it's slow, and it's not... You know, anyway, that's what Peloton was. So who's John Foley? [chuckles] Uh, this is, like, it's such a small world out there. He had been, prior to starting Peloton, he had been the head of Barnes & Noble's Nook business there-
- BGBen Gilbert
[laughing]
- DRDavid Rosenthal
... e-reader business [chuckles] uh, which was based in New York. And it was like, actually, you know, Barnes & Noble was a, you know, great company, and then eviscerated by Amazon. And the Nook business, uh, and the Nook product, I think, was probably a decent product, but it was just sort of too late.
- BGBen Gilbert
And they were really a fierce competitor in this market. I mean, they, they outlasted Borders.
- DRDavid Rosenthal
Totally. But, you know, it's interesting, too, thinking about the book and e-reader market relative to Peloton, too, and maybe some lessons that Foley learned from that. You know, you could have the best hardware in the world, but you needed the books. [chuckles] Like, the content was what really mattered. It didn't matter if the Nook hardware was better than the Kindle or not. Like, Amazon had the biggest selection of books, the easiest buying experience, and had the most lock-in.
- BGBen Gilbert
Okay, I do have to pull forward that thing from what would have happened otherwise, 'cause t- it's, it's... W- We can save the analysis for later, but I should share what actually happened. So you might be giving Foley a little bit too much credit here. When he was starting the business, they wanted to build the best bike, a beautiful piece of hardware, like Apple. They wanted to build software that was, uh, equally elegant and really differentiated, uh, that bike. The original vision actually was a connect-your-own-iPad vision. They, they did not want to unify it, but sort of learned over time that we really do need to unify it to control more of the experience. But here's the interesting thing, they actually didn't want to produce their own content. They thought, "If we have a bike, w- even if it's, you know, like, uh, a bike with our software, that's interesting enough to people, and we can partner with either SoulCycle or Peloton-
- DRDavid Rosenthal
Oh, or, or Flywheel, you mean?
- BGBen Gilbert
... Or Flywheel, yeah, to get access to their instructors, their content. That's the thing they're good at, is the content. We'll just make this elegant device. And they actually got to term sheet with i- uh, with, um, Flywheel. I think SoulCycle sort of gave them the cold shoulder as sort of... You know, they were so hot at the time, and so big and so dominant. But, uh, Flywheel, they actually got to terms on what would it look like to make this thing, uh, not only, um, a content partner, but I think also, like, a go-to-market partner. Like, this was gonna be the distribution strategy. But Flywheel ended up pulling out and walking, walking away from the deal. So Peloton were sort of forced to do their own content and, and pivot to a really vertically integrated strategy.
- DRDavid Rosenthal
Oh, my gosh. Talk about history turning on a knife point. [chuckles] Wow, what a... Like, uh, just like the echoes of the Blockbuster-Netflix, uh, situation. Uh, and, and, and Amazon. Remember, Netflix tried to sell itself to Amazon. [chuckles]
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
Oh, amazing! Okay, so that's what Foley was doing immediately before, um, before starting Peloton. But before that, he had been a longtime IAC guy, Interactive Corp, working for Barry Diller. Like, oh, my God!
- BGBen Gilbert
The original tech media conglomerate. I mean, like, I, I'm kind of annoyed at the number of people that try to characterize John Foley as someone who, you know, was breaking into the industry or didn't have a tech background, or... No, he was in the middle of this stuff in the late '90s, early 2000s.
- DRDavid Rosenthal
... We should do an episode on IAC, 'cause it is fascinating. Barry Diller, and media, and tech, and, and, uh, him being really the first person to integrate all that. But for a long time, sort of the jewel of IAC was QVC and the Home Shopping Network. [chuckles] And what is that? That is, like, literally streamed media out via, you know, television, with an interactive component that people at home were, you know, buying and calling and inter- Like, ah, the DNA is just, like, so, so perfect.
- BGBen Gilbert
So what was John doing at IAC?
- DRDavid Rosenthal
I believe he was working on part of the City Search team, and then he also- they had a business called pronto.com, I think. I'm not sure exactly what that was doing. But he had bounced around, and, yeah, I think a lot of people at IAC, you know, go between a whole bunch of their properties.
- BGBen Gilbert
Yep, and I think... I'm not sure if this was IAC or his, his next gig, but he ended up taking over the post-bubble Evite team, that had shrunk from, like, hundreds and hundreds of people down to this, like, very small group, and grew it to, like, I think he grew it from, like, a million bucks to twenty-five million in revenue or something. Still, you know, relatively small on the- to compare to the grander scale, but, um, you know, had, had sort of done this, take a startup and, uh, rehab it and build it bigger. So he hadn't actually done a startup from scratch but had built something meaningful with a small team.
- DRDavid Rosenthal
Man, Evite, that's like the cockroach of the internet, [chuckles] like-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... in a good way. [chuckles] You just, it just won't die.
- BGBen Gilbert
Yes.
- 38:06 – 44:38
Early traction was hard: funding rejections, Kickstarter, and the mall store strategy
- DRDavid Rosenthal
Ah, amazing. Uh, so you would think, like, you know, gosh, we're telling this story now, and hindsight is twenty-twenty, like, incredible vision, proven demand for this product. Like, yes, it's gonna be hard to build a full-stack company around this, but, like, financing hard stuff, like, that's what builds moats. Like, this should be an easy fundraise. And Ben, as you referenced, the John's episode on, on How I Built This is great around all this, so we won't rehash all of it. But it was incredibly [chuckles] hard to get this funded. Like, all the VCs passed again, and again, and again. They end... He ends up raising four hundred thousand dollars to start [chuckles] from friends and family at a two-million-dollar post-money valuation. [chuckles]
- BGBen Gilbert
[chuckles] Yes.
- DRDavid Rosenthal
Oh, my gosh, and of course, you know, folks probably all know now, uh, I think it's later in my notes, maybe what the current market cap of Peloton is, but at its peak, it was a forty-five billion dollar public company.
- BGBen Gilbert
IPO'd at eight billion, went all the way up to, I think, forty-nine billion, uh, and then today is floating a little above the IPO price, between nine and ten billion.
- DRDavid Rosenthal
Wow! [chuckles] I mean, from a two-million-dollar post-money valuation for that first round. I mean, that's twenty percent of the company he sold for four hundred thousand dollars.
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
Phew!
- BGBen Gilbert
All from individuals, twenty-five K and fifty K checks.
- DRDavid Rosenthal
And then did a three-and-a-half million dollar round, I believe, also all from individuals after that. Uh, they do a Kickstarter in 2013. I had forgotten this-
- BGBen Gilbert
I can't believe this thing was a Kickstarter
- DRDavid Rosenthal
... until it got pointed out in the Acquired Slack. Like, it was a [chuckles] Kickstarter, and it was, like, essentially a failed Kickstarter. Like, it didn't technically fail, but it was-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... not good. [chuckles]
- BGBen Gilbert
So here's the thing, um, l- I just pulled it up. We'll, we'll link to the Kickstarter page in the show notes, which, by the way, has basically the bike exactly as it is today on there-
- DRDavid Rosenthal
It's unreal
- BGBen Gilbert
... from eight years ago.
- DRDavid Rosenthal
Aside from what? Like, the weights holders, and they t- they tweaked the-
- BGBen Gilbert
The water bottle, uh, location.
- DRDavid Rosenthal
It's the same bike. [chuckles]
- BGBen Gilbert
Yeah. So they raised three hundred and seven thousand, three hundred and thirty-two dollars in the Kickstarter. Their goal was two hundred and fifty, and John says on the How I Built This episode, that half the people who backed the Kickstarter were already investors. So i- i- it's a very interesting thing here, where we all know Peloton is a killer product. I mean, you and I rave about it. They have these ludicrous N- NPS scores, and yet, when they laid out the vision, and they showed a very well-produced video with, a, like, a very... You know, uh, you get a sense of what the experience is like from this video. It was not enough to communicate to people that this thing is gonna be awesome, and so I think it's worth pointing out that until you actually tried it-
- DRDavid Rosenthal
Yeah
- BGBen Gilbert
... you didn't know it was gonna be good, which makes it a pretty hard thing to sell.
- DRDavid Rosenthal
Totally. We're gonna get into this more in a sec, but yeah, this is not, a- at least in the early days, things may be different now, although maybe not. We'll discuss. Um, yeah, this product is not something you can really just sell over the internet. Like, you got... Like you said, you either gotta try it or you gotta have a bunch of friends who are using it and being like, "This is awesome."
- BGBen Gilbert
Right. There needs to be sufficient social pressure or your own experience.
- DRDavid Rosenthal
Well, let's go right into, like, how do they [chuckles] start and end up selling it? They [chuckles] make the, especially at that point in time, completely orthogonal decision to how, you know, tech companies and startups were supposed to sell. They go to the Short Hills Mall in New Jersey, and they [chuckles] rent a store in the mall and set up a mall store, [chuckles] and they start selling these by hand in the mall.
- BGBen Gilbert
It's a beautifully contrarian bet to say, "Our strategy is to go to malls," which, by the way, they continued to do, like, hundreds and hundreds of in-mall stores as malls across America are declining. But they did have the realization, I don't know if it was, uh, super explicit as a strategy, but the, the realization that, "Hey, until you try this thing, like, you actually don't understand how awesome it is." Like, you can hear it described to you, but it's not compelling enough to buy, especially at this high two thousand dollar a bike.... plus a subscription fee price point. And so the mall was sort of necessary, and they have these anecdotes about how people actually weren't in the market to go buy gym equipment. But they're walking by, they try it, you know, they, they have someone size the bike for you, you throw on the headphones. Their, their goal, their sort of KPI, is get you in the experience as soon as possible after stepping in the store. And this is, by the way, how I bought mine. It, it is like, uh, you wander in, and-
- DRDavid Rosenthal
You bought it in the mall?
- BGBen Gilbert
I did, yeah. I had intent-
- DRDavid Rosenthal
Wow!
- BGBen Gilbert
- beforehand, but it is this experience where they're like: "Do you wanna try it?" And they make it easy and fun to try. And then once you're in, and you've, like, got headphones on, and typically people are together, so you look at your partner or whoever, and then you're like, "Whoa!" And it, like, it takes all of three to five minutes before you're like: "Oh, I see why this could be cool." And they needed the mall store as the way to sort of do this.
- 44:38 – 52:52
Premium pricing + sticky subs: raising the bike price to signal value and reduce churn
- DRDavid Rosenthal
But, yeah, okay, so you mentioned price, $2,000 bike. So [chuckles] the... At the Kickstarter, I think they priced it at, like, 1,500 on the Kickstarter-
- BGBen Gilbert
Yep
- DRDavid Rosenthal
... I think, as early. But then, when they first tried to start selling these things, they priced it at $1,200, and it wasn't selling. This is, like, fascinating. This is a fascinating little detail. And then they talked to some people about this, so you're getting customer feedback, and what they realized was that for $1,200... Like, they're thinking, like, "Hey, the strategy is to sell the hardware, you know, at cost or at a loss." It's like the video game console strategy. Like, "Get the video game consoles in there, and then we, we've got this awesome subscription business that we're gonna layer on top of it, and that's where we're gonna make our money." People thought it was... The hardware couldn't be that great if it was $1,200, and they realized that if they raised the price, they raised the price up to $2,245, that then in people's minds, this becomes this, like, jewel, premium, expensive, aspirational luxury product. Like, "I'm treating myself to this splurge 'cause it's so awesome, and I'm gonna, like, love it." And at the $1,200 price point, uh, they, it was, it was hurting that. It was, it was preventing that from happening.
- BGBen Gilbert
That's absolutely fascinating.
- DRDavid Rosenthal
So they didn't change a thing about the bike. They just raised the price by 1,000 bucks.
- BGBen Gilbert
You know, in the, in the Buffett parlance of, "Price is what you pay, value is what you get," they're using price to signal value.
- DRDavid Rosenthal
And that's supposedly another one of the big things that really helped, uh, really helped sales take off.
- BGBen Gilbert
Well, yeah, so the, I, I'm gonna pull forward a playbook theme here. So the n- second-order thing that I don't think they realized by jacking up the price is that now they're picking their customers, and they're picking affluent customers, and in particular, they're pi- picking customers who have extremely low price sensitivity. And what happens when you pick people with extremely low price sensitivity, and you select for only people who are willing to throw $2,300 post-tax at an exercise bike? They're pretty unlikely to churn, even if your fitness subscription is pretty expensive. And so even to this day, their annual churn, if you sort of take their monthly churn and annualize it, is something like 9%. This is an unbelievably sticky business. When you look at most consumer businesses, they're, like, 50% annual churn.
- DRDavid Rosenthal
Yep. As of last summer, so they're on a June 30 fiscal year end, so when they reported their last full year fiscal end, I believe churn was, like, 0.6... Monthly churn was, like, 0.6%, worked out to about 7% annual churn.
- BGBen Gilbert
Wow!
- DRDavid Rosenthal
Which, like, that's... Those are Netflix numbers there. [chuckles]
- BGBen Gilbert
I'm not sure. Yeah, I th- I think it's meaningfully better than Netflix. May- maybe I should look at what Netflix's churn is, but I think that that is the best I've ever seen. So on the one hand, it's hard to acquire customers 'cause you gotta go sell them a $2,400 bike. On the other hand, once you get them, boy, is that sticky.
- DRDavid Rosenthal
So I don't know what revenue was for 2014, uh, which is their first kind of full year of sales, and, uh, they implement some of these strategies. I believe it was $10 million-ish. In 2015, though, they do $60 million of revenue, and ahead of that, at the end of 2014, [chuckles] they are able to raise their first institutionally led round of capital, this is 2014, led by the legendary, you know, [chuckles] early-stage investor. It is technically a Series B, but the, the seed was the 200, uh, $400,000 round, and then the, the A was the, you know, still individuals, $3.5 million round, led by the legendary seed investor. They are quite now [chuckles] a legendary seed investor, among others. Uh-... Tiger Global. [chuckles] Get out of here, this is amazing!
- BGBen Gilbert
It's an unbelievable bet by John Foley in twenty fourteen. It was a ten million dollar total round on a thirty-five million post, where Tiger put in five million. Tiger would go on to become the largest shareholder at IPO, owning just under twenty percent of the business.
- DRDavid Rosenthal
Amazing. Amazing. Like, there's so many little things about this story that just sorta, you know, presage everything that would be to come [chuckles] in, uh, in tech over the years, uh, and i- and in venture. So yeah, Tiger leads the first institutional round.
- BGBen Gilbert
I do think, by the way, this is one of the things that w- gave, among many other very successful investments, but was a big part of the story for John Foley to... When he s- left and started Addition and ro- and raised over a billion dollars for Addition's first fund. Uh, Peloton was a big, big part of that.
- DRDavid Rosenthal
Yep. Yeah, for John Foley, for Addition, you know, and for Tiger itself, too. I mean-
- BGBen Gilbert
Yeah
- DRDavid Rosenthal
... got to imagine that that was a big part. They're notoriously tight-lipped. Our friend Mario Gabrelli wrote, I think, the best piece out there on them, uh, which was still without, without insider access, um, but shaped their strategy, too. [chuckles]
- BGBen Gilbert
Yep.
- DRDavid Rosenthal
So sixty million dollars in revenue in twenty fifteen. Twenty sixteen, they do a hundred and seventy million dollars in revenue. Twenty seventeen, they raised three hundred and twenty-five million at a one point three billion dollar valuation, and this is where I think Silicon Valley really started to wake up and be like: "Oh, my God, we missed this! [chuckles] How did we miss this?" [chuckles]
- BGBen Gilbert
Yep, 'cause he, he pitched everyone. Everyone.
- DRDavid Rosenthal
Literally everyone. Uh, twenty eighteen, they introduced the Tread product, uh, the treadmill and the digital app subscription. It'd be fun to talk about that. The... You know, I started as a digital app subscriber, and then-
- BGBen Gilbert
Which is how? It's, like, thirteen dollars a month.
- DRDavid Rosenthal
Yep, it was twelve ninety-nine. I think I originally started- 'cause I think there might have been, like, a, some- a deal with Apple or somebody, like, a first f- try- a free month trial or something like that.
- BGBen Gilbert
Were you a part of the COVID offering, the three-month COVID thing?
- DRDavid Rosenthal
Yeah, I think that might have been.
- BGBen Gilbert
So that, that was totally nuts. So John Foley talks about this. He says, uh, a- about the beginning of COVID, he said: "Six months ago, we had about a hundred thousand digital subscribers for the business," and within forty-five days of COVID hitting, uh, they, they, um, gave this deal that said, "W- you're not getting a month free, you get three months free, because people need to work out at home." And within forty-five days, we had close to one point two million people who had jumped on the trial, so call that a 10X increase in weeks.
- DRDavid Rosenthal
Wow!
- BGBen Gilbert
So that was a very... I mean, w- again, we'll get into the unit economics of it later, but, uh, at least from a customer acquisition perspective, that was a great way to spike the number of subscribers they had.
- 52:52 – 1:16:23
IPO-era economics + the music licensing margin trap
- DRDavid Rosenthal
Uh, okay, so I know you've got some fun stuff on this. Twenty nineteen, people start talking about... Everybody in Silicon Valley knows this is a great business now. People start talking about an IPO, going public, which happens in September 2019. But leading up to that, there's kind of an issue with the business that they've gotta sort out, [chuckles] which is, uh, earlier in 2019, they get sued for first a hundred and fifty million dollars, and then they up it to three hundred million dollars by the music publishers, National Music Publishers Association, uh, because they're obviously using all this music as part of the classes at Peloton, and they didn't have the proper sync licenses.
- BGBen Gilbert
Yes, so this is my b- one of my larger bear cases for Peloton. So, uh, m- music licensing and gross margins, uh, a, a treacherous tale. Well, if you look at Peloton's income statement today and, and across recent quarters, so we're, we're at sort of a relative point of maturity here, uh, about a third o- of the revenue that comes from subscription, so not like the physical bike sales, but if you just look at the subscription revenue, a third of that goes to cost of revenue, and while we don't know for sure, it's very likely that the majority of this goes to music licensing. So even though investors love a good subscription business, uh, this is not eighty-six percent gross margin like SaaS is. I- it's more like sixty-six percent gross margins. So w- a little examination, why do we think that this mostly goes to music? Well, in part, the variable cost for everything else should be pretty low. I mean, maybe bandwidth is probably the next highest cost for, for streaming video. I have some particular beef, uh, as a pedantic person with the video that they do stream. I find it to be too low frame weight-... too low frame rate, uh, to have some motion blur, to be a little bit compressed, but all that aside, it's still expensive to stream v- video.
- DRDavid Rosenthal
Now, d- do you know, do they put, um, content production cost in variable costs here, too?
- BGBen Gilbert
I don't know if that is in the cost of revenue for the subscription. I would guess not. I would guess they would put that, uh, down in, in either G&A or-
- DRDavid Rosenthal
I don't know. It might be in there, but, you know, I, I, uh... And I don't, I don't know, I haven't dug in deep enough to know, but I, I don't think it's that expensive relative to the amount of subscription revenue they get. We'll get into powers later, [chuckles] and scale economies, and all that, but, uh, my understanding is that the top Peloton instructors make, like, 500K to a million.
- BGBen Gilbert
Yeah, I think that's about right.
- DRDavid Rosenthal
And then obviously, you've got all the production costs around that, but, like, still, compared to, you know, hundreds of millions of, uh, of subscription annual revenue, that's a drop in the bucket.
- BGBen Gilbert
Totally. So okay, let- let's assume that the largest part of this 33% of cost of revenue is, is to pay for music. So why is the music so expensive? Well, if you remember from our Taylor Swift episode, there's a bunch of different types of licenses, and unlike Spotify-
- DRDavid Rosenthal
Yes, I knew you were gonna get into this. [laughing]
- BGBen Gilbert
[laughing] Or the radio, Peloton actually requires multiple licenses for the particular way that they use the music. So first, uh, Peloton, I think, is technically, just like the radio, a live performance, so, uh, live performance royalties must paid out- be paid out, and if you are curious for how those are paid out, go listen to the Taylor Swift episode, where we talk about the difference between the publishing rights holder and the performance master right holder. Uh, but they also need a sync license in addition, to synchronize those songs with the video content. Uh, if you're gonna, you know, use a license in-
- DRDavid Rosenthal
A commercial or a movie.
- BGBen Gilbert
Exactly. And j- just as a quick aside, an aside from an aside, the interesting bit about sync licenses is they require the approval both of the sort of songwriter, the person with the publishing right, and the performing artist who owns or, or whose label owns the master right. So there's a lot of people who can say, "No, I don't grant you a sync right," which is why, in this lawsuit that you're referencing, David, when Peloton did end up pulling a bunch of stuff off of, uh, the service, which a, a lot of people were really upset about, it was weird, 'cause so you're like: Wait, but some of this artist's songs are on there, and some rides with those artists' songs got removed, and that's because those songs had different songwriters behind them.
- DRDavid Rosenthal
Yeah. Ah, so many people with veto power. What a Byzantine industry!
- BGBen Gilbert
Crazy, right? Okay, but back to sort of this, like, gross margin problem. So according to a piece, uh, uh, from Trichordist, which is a music industry site, Peloton pays out 3.1 cents every time that you are on a ride and hear a song. That number should actually sound pretty high to you because that's meaningfully larger than what we talked about on the Taylor Swift episode per stream. So let's take that 3.1 cents. If you ride every day, and people don't ride every day, but I think people ride about 20 days, or they use the, the, the product about tw- 20 times per month. But let's say you ride every day, and assume there's about 10 songs per ride, and I went back through my recent rides and looked, that's about right. That's $9 of your subscription revenue that is going straight to music. So if you're on the bike subscription, that's, like, 23% of your subscription that you're paying to Peloton goes immediately to the labels, which kinda checks our math above, that the biggest part of that, that, you know, one-third of the cost of revenue is actually for music. Now, o- of course, if you're on the digital-only subscription, that's really high, 'cause that's only $13 a month. If you're actually using that thing every day, I assume the royalty structure is similar. It may be the case that Peloton is, uh, large enough that they've negotiated a specific revenue share, you know, somewhere between 15, 25, 30%, something like that, uh, w- with the music labels, rather than needing to pay out a fixed amount per song. Because if it's a fixed amount per song, then they could get underwater pretty quick on that digital-only subscription.
- DRDavid Rosenthal
God, the parallels to Spotify are just, like, amazing, with, like, the two different tiers of customer experiences and, like, vastly different implications of that for their back-end costs.
- BGBen Gilbert
100%. I mean, it is, uh... Okay, you, you're leading the, the horse to water. I'm the horse. Here's the water. So-
- DRDavid Rosenthal
[laughing] Ah.
- BGBen Gilbert
Because there are very real marginal costs in this business, just like Spotify, at the end of the day, this actually does have the same incentives that a gym membership would have, like an old-school gym membership, which is sign you up, keep you subscribed, but really no incentives for you to actually go to the gym all the time.
- DRDavid Rosenthal
Mm.
- BGBen Gilbert
They kinda want you to do the minimum amount, like, to stay subscribed, like, "Stay engaged enough with us, but don't cost us any money. You know, we wanna, like, minimize the amount that we have to pay the music labels on your behalf," which is interesting. So I was thinking about this, you know, like, uh, prepping for the episode, and I slept on it. When I woke up this morning, I kinda realized, because they're bragging about, in their, all their earnings stuff, increasing user engagement over time and having internal KPIs around, "We want people to use the service," I sorta came to this conclusion that they have to have a pre-negotiated revenue split with the music labels rather than paying per stream. Because Peloton could end up in a really tough position if their own incentives are for you to stay subscribed but not ride. So I bet-... they did some kind of, like, blanket license type thing, where, you know, 20% or 25%, or whatever it is, ends up, of all subscription revenue, no matter what, ends up going to the labels.
- DRDavid Rosenthal
Well, if they don't have that, they probably have a new CEO who could help make that happen. [laughing]
- BGBen Gilbert
[laughing] Very much so. Very much so.
- DRDavid Rosenthal
Uh, if they don't, they should, and now they probably can.
- BGBen Gilbert
Yes. One last, like, quick piece of math, just to underscore the gravity of this. I ran the math on what it would cost Spotify to pay the labels for the same amount of music listening time, based on the data that we used in the Taylor Swift episode. So, you know, uh, 15 hours across a month, so I was thinking the same as like, you know, te- a 30-minute ride every day for a month. And instead of the $9 that I sort of estimate that Peloton has to pay, Spotify is closer to, like, a buck 20.
- DRDavid Rosenthal
Wow! That's massively different.
- BGBen Gilbert
That sync right and the performance license is very expensive. So, you know, Barry is definitely used to the Spotify world of, we, we pay a pittance to, to, you know, the, the labels and the artists. And in this world, because of the license structure, it's a meaningful part of COGS.
- DRDavid Rosenthal
One way to look at it is it's a meaningful part of COGS and sort of in the, the bare lens. Another way to look at it is, like, artists should really embrace Peloton. [chuckles]
- BGBen Gilbert
Yes, very much so. Which you gotta wonder, is that part of what's driving, like, the Taylor ride series and the Beyoncé ride series, and the, uh... Peloton is notoriously very collaborative with the most popular artists.
- DRDavid Rosenthal
So September 2019, they've settled this lawsuit, they figured things out, at least with the sync licenses. Uh, they go public, the IPO happens. S1 hits, fiscal year 2019, so fiscal year ends June 30th, as I've said, so for the 12 months leading up to June 30, 2019, it did revenue of 915 million. For a five-year-old company, that is... Or a five-year product that's been in market for five years, that is impressive. That is up over 100% from 435 million the year before. Of that 915 million, 181 million is subscription revenue, which is up from 80 million the year before, so growing even faster. Um, we already talked about the margins on the subscription revenue. Interestingly, the hardware revenue, connected fitness products is the segment they call it, also about a 40% gross margin. So there, this is the benefit of, you know, raising the price $1,000. [chuckles]
- BGBen Gilbert
Right. Right, they actually make pretty good margins on selling the bike itself. So, uh, I couldn't find this, mostly 'cause I was scrambling for just the last day to put together everything we did learn. Um, if you have data on this, please come and share it with us, acquired.fm/slack, and we would love to talk about this. I remember, around the time of their IPO, seeing some analysis that said that they basically were break even on the bike, if you add in customer acquisition costs. So the cost of manufacturing the bike and delivering it, and all that, plus the, the cost to acquire, which was really expensive. You know, they're in these malls, they're sending you a ton of social media ads. They're really trying to convince you, you know, they're putting on Super Bowl commercials, [chuckles] which we'll get to. They're putting on other commercials, where people are in these multimillion-dollar homes, riding in fancy places. It's expensive to, uh, you know, convince people to do this new behavior. And, uh, I think the, the plan at the time is like, "Okay, don- just don't lose money acquiring a customer when we sell them a bike. And as long as we're kind of break even on that, then we can make a lot of money on the subscriptions."
- 1:16:23 – 1:31:41
Pandemic boom to operational whiplash: Bike+ missteps, truck rolls, and manufacturing bets
- BGBen Gilbert
All right, so David, uh, tell everyone why I was the most fortunate person in the world [chuckles] to, uh, in January 2020, have just so happened to have bought a Peloton at that-
- DRDavid Rosenthal
Oh!
- BGBen Gilbert
... moment in history.
- DRDavid Rosenthal
I didn't realize you... So you bought it before the pandemic?
- BGBen Gilbert
I bought that and my car in January of 2020-
- DRDavid Rosenthal
Oh!
- BGBen Gilbert
... totally randomly-
- DRDavid Rosenthal
Nice
- BGBen Gilbert
... and by happenstance, which both ended up being unbelievable assets to have.
- DRDavid Rosenthal
I actually bought a, uh, Olympic weight set off Craigslist right at the same time.
- BGBen Gilbert
No way!
- DRDavid Rosenthal
So not as, not as high value as you, but, like, stuff that, like, immediately became unavailable.
- BGBen Gilbert
Gold. [chuckles] Yeah.
- DRDavid Rosenthal
I paid, like, 180 bucks maybe for, like, a full Olympic weight, weight set. It was awesome.
- BGBen Gilbert
Which now is, like, $1,000.
- DRDavid Rosenthal
Yeah, so great. So the pandemic hits, you know, like you said. If Peloton had very good product-market fit with a certain narrow customer segment before the pandemic, was a great business. The pandemic made it have instant product-market fit with many, many more segments. They add roughly a million subscribers in the next year. Revenue in, uh, the fiscal year, ended June 30th, 2020, is $1.8 billion. In the fiscal year, ended June 30th, 2021, is $4 billion. The stock trades up, as we've talked about, to a peak of over $150 per share at a 49, I believe, billion dollar market cap. People think this is going to the moon, and, like, rightly so. I mean, it's an amazing product. Uh, [chuckles] if, you know, fitness has now become fully digital, they are the leader in the category. Uh, you know, so much, so much to love here.
- BGBen Gilbert
There, there's a zillion copycats, not just in the, like, you know, NordicTrack and Target making black-and-red bikes and making up Peloton-like sounding names for them, and-
- DRDavid Rosenthal
Oh, yeah, there's, like, Echelon out there and-
- BGBen Gilbert
Oh, it's crazy. But also pioneering this category of connected fitness, which says, "Sure, Peloton's gonna do a tread and a, and a bike, but they're not gonna do a mirror and a, and a, you know, band-based weight set and, uh, you know, and a yoga thing." Like, there, there, there's all these brands that are saying, like, "Eh, Peloton does a little bit of that, but that's not their core competency, and they're never gonna take it seriously." So there really is this super real category of connected fitness that Peloton totally pioneered.
- DRDavid Rosenthal
I, I'm curious your thoughts. Connected fitness, both within the Peloton suite of products and competitors, is it a broad thing, or is this something that just works really, really well for spin classes?
- BGBen Gilbert
Great question. I've done a bunch of the Peloton strength stuff. I think that works well, and I think that the Peloton strength-... uh, classes definitely appeal to a crowd who is not going to buy an Olympic weight set in their garage or is not going to go to a gym. Um, I know people with the Mirror who are very happy with that. I, I think it's pretty broad. I think the bike is k- is the first and best instantiation of it. Interestingly, Foley, and, uh, and I think he's right on this, I think this isn't one of his sort of, like, grandiose statements that ends up not being true, thinks that the tread market is, like, three X what the bike market is, because running is a much more-
- DRDavid Rosenthal
Really?
- BGBen Gilbert
Like, treadmills are a bigger thing, I think, than stationary bikes.
- DRDavid Rosenthal
Well, they also sell the treadmill for a lot more money.
- BGBen Gilbert
That's true, too.
- DRDavid Rosenthal
It's interesting, right? Like, the running mi- it's different, though. Like, the... I'm sort of halfway in between on this. I agree with you. I, I both have an Olympic weight set in my garage, but I use the Peloton strength stuff more often, especially as I, like, get a little older, and the idea of, [chuckles] you know, squatting and bench pressing is less appealing to me. Um, uh, I think the s- the strength stuff is pretty good, but I can't imagine buying a treadmill or using, uh, a connected fitness for running.
- BGBen Gilbert
It's so true.
- DRDavid Rosenthal
But, but we're lucky we live on the West Coast, we can run outside-
- BGBen Gilbert
Yes
- DRDavid Rosenthal
... year-round. There's plenty of places where that's not possible.
- 1:31:41 – 1:44:44
Demand hangover and reset: tread recall, inventory glut, activists, and Barry takes the helm
- DRDavid Rosenthal
Yep. Again, cash outlays. Uh, and, uh, and then in, in the spring of 2021, there's the treadmill recall and some of the tragic accidents, uh, around, um, you know, with the treadmill. The company doesn't handle that super well. At first, they sort of say: "Oh, people aren't using it right." It's like, well, kids are, like, dying and getting hurt here, like, that doesn't matter. Um, uh, stock drops 15% around that.
- BGBen Gilbert
They issue a mea culpa and say, "You know what? We are gonna play ball with the investigation. We feel super bad that we mishandled this originally."
- DRDavid Rosenthal
And then November of 2021, last fall, they miss earnings, they cut their outlook, and the stock gets hammered, down 32% in one day with the earnings announcement. Uh, [chuckles] they have some more holiday season, uh, media commercial, uh, uh... This is also probably good with the, the new Sex and the City, where Mr. Big dies on a Peloton. [laughing]
- BGBen Gilbert
I-- No, 'cause that tanked their stock price, and it never recovered.
- DRDavid Rosenthal
It did. It did. Although, I know, that to me feels like, uh, the wrong reason to, uh, to sell the stock.
- BGBen Gilbert
I mean, yeah, but it's indicative of, uh, the-- I think when something like that happens, th- th- So someone died on Sex and the City, and, uh, was on a Peloton, and Peloton's stock dropped, and you might say, That's so stupid. But I think the... What to read into that is, people are on such uneasy footing about th- th- the future prospects of this company, that merely imagining that something like that could happen is enough to spook investors, and that says a, a lot.
- DRDavid Rosenthal
That says way more than the Sex and the City episode. Yes. So then, the other shoe drops, the other [chuckles] cycling cleat drops. On January 20th, news comes out that supposedly Peloton is completely stopping production of new hardware, as they have an inventory glut that they can't sell. Demand has completely dried up. It all got pulled forward through the pandemic, and this is bad news.
- BGBen Gilbert
There's a $1.3 billion worth of inventory that they're sitting on now.
- DRDavid Rosenthal
Yep. Yeah, so we went from literally, they can't make this stuff fast enough, they're hiring delivery teams all across the country and around the world, delivering bikes into people's homes, picking them up [chuckles] and servicing them, bringing them back, to now they can't sell these things.
- BGBen Gilbert
There's a lot of things to applaud the management team about, and John Foley, and the doggedness, and the entrepreneurism, and the in- inven- pure invention of a movement, and recognizing talent, and hiring the right instructors, and finding ways to align incentives, and building this pr- like, so much. The one that is really, really damning is all the quotes that Foley and other folks gave along the way, saying: "Sure, this pulled forward demand, but we think it will only ever be more. We think we will only ever continue to sell more and more of this stuff. Demand is just gonna keep growing," and they were just completely wrong. Like, completely wrong! The, the incredible slowdown, like, the really, really scary slowdown that has happened for them, is to the point where they only grew 9% in Q4, and then 5% in revenue in Q1. And this company just believed that there was way, way, way more demand out there, "and sure, the, the pandemic accelerated us, but we're not gonna have to sort of make up for everything that was pulled forward. It's just gonna continue to be high demand from here," and they were just flat-out wrong.
- DRDavid Rosenthal
Totally flat-out wrong. And we'll, [inhales] uh... Well, we'll wrap up the few last points to bring us to, to literally today, present day. But, uh, one of the things when they released earnings yesterday is they cut guidance. Guidance had been for full fiscal year revenue of four to four-and-a-half billion. They cut it down to 3.7 to 3.8, which is actually going to be down, like, revenue is going to be down sequentially, year on year, this year versus last year. [chuckles] Like, that is not- that is not good. That is not good for a growth company.
- BGBen Gilbert
No, and you look at the, the level of certainty that they had, that it w- that they just needed to keep expanding to service all this demand. Not only did they plunk over $800 million into manufacturing capacity between Precor, which has its own business, so it's justifiable, um, assuming they paid a reasonable price for it, and of course, the, the, the Ohio factory, but v- you look at their employees... I mean, they were growing employees pretty quickly from 2015, '16 to 2020. But when you look at, as of January 2021, they had 4,000 employees. That ballooned, it, over the next year to about 9,000 before these recent layoffs.
- DRDavid Rosenthal
Now, this is a very complex business, but, like, 9,000 employ- and that's just corporate, right?
- BGBen Gilbert
No, that's, that's everyone.
- DRDavid Rosenthal
Oh, that's everyone. Okay.
- BGBen Gilbert
Yeah, yeah. And the layoffs, of, of course, were 2,800 people across the whole business, and I think about 20% of the, the corporate staff, but they were really, really investing, uh, uh, and very certain this demand was there.
- DRDavid Rosenthal
Yep. So after that news on January 20th, a couple weeks later, an activist investor called Blackwells Capital comes out and announces that they've accumulated a 5% stake in Peloton. The share price and market cap, of which, by the way, have dropped below the IPO price, which [chuckles] as we chronicled, was not a great IPO in and of itself.... And they publish a deck calling for Foley to resign and for the company to initiate a strategic sale process. Uh, and that brings us to yesterday, February 8th, 2022, where they announce earnings. They're bad. [chuckles] They lower guidance significantly. They pull the plug on Peloton Output Park. They cancel the plans to build the manufacturing facility in Ohio. They lay off 2,800 people, and Barry McCarthy is riding in as the new CEO.
- BGBen Gilbert
And the way they sort of message this is that John Foley is stepping down as CEO, which is the-
- DRDavid Rosenthal
Or at least that's what people hear.
- BGBen Gilbert
That's what people hear, and it's somewhat to appease these activist investors. But let's, like, zoom in on what mechanically is actually happening here. So John Foley becomes the executive chairman. Now, what an executive chairman is, as compared to a non-executive chairman, is they're still the chairman of the board or the chairperson of the board. Uh, they no longer have day-to-day responsibility running the company. Uh, however, I believe they still are a compensated employee. They still draw a salary. They're still, like, a, an employee of the company in addition to being, um, [lips smack] uh, uh, just a board member. So they share both this sort of like director level and, um, pseudo-operational. It's more like they're working with the current CEO, uh, to, to sort of set strategy with them. And so while they're not running the day-to-day, they are still the senior-most person, uh, who is an employee of the company. And I don't think it would be correct to say that John Foley is currently Barry McCarthy's boss, but it totally is fair to say that John Foley is on the board, is the chairman of the board. The board hires and fires the CEO, and... And here's the real kicker on this whole thing: as many of you will know, we've been on a heck of a run over the last 20 years of having dual-class structures put in place for founder-led companies. Uh, and here's a quote from Matt Levine at Bloomberg: "Peloton has a dual-class structure, uh, in which the founders and some insiders have stock with 20 votes per share, and Foley has a lot of it. According to Peloton's proxy statement, he controls 39.6, so right around 40%, of the voting power of Peloton's stock, and his co-founders own another 18%."
- DRDavid Rosenthal
So there you go. That's enough to-- That's over 50% of the voting power of the company right there.
- BGBen Gilbert
Right. Foley can't do it alone, but with o- one, probably, uh, certainly both of his other co-founders, basically can make a unilateral decision. So the message Peloton wants Blackwells and other upset shareholders to hear is, "John Foley has sort of moved on, stepped down as CEO, uh, and we've brought in Barry McCarthy." In practice, dude still holds the cards.
- DRDavid Rosenthal
It's more complicated. Now, uh, all that is true. At the same time, I don't think Barry would take this job if he didn't feel like he had full autonomy.
- BGBen Gilbert
Totally agree.
- DRDavid Rosenthal
And the memo that he writes to staff, which we've already read some... From some of it, and I wanna read a bit more because it's amazing, and it's like Barry is like, who wouldn't wanna work for Barry?
- BGBen Gilbert
He's a great leader. Yeah.
- DRDavid Rosenthal
Oh, what a leader. So he writes, "I know today's restructuring news has been difficult. There's no sugarcoating it. It's a bitter pill, and in my experience, the sting has a long half-life. But the hard truth is either revenue had to grow faster or spending had to shrink. The math simply didn't work otherwise, and the status quo was unsustainable. One of my core management principles is about getting real. We have to be willing to confront the world as it is, not as we want it to be, if we're going to be successful. We have to be honest with ourselves and with each other in order to make that happen, even when the truth is uncomfortable or inconvenient to deal with." And then, Ben, I think you, you read the, the great, the great part about the, the comeback story, uh, after that. You know, and then he closes it. He says, uh... When he closes the memo, he says, "In the months ahead, you can expect to hear from me about our strategy and the choices we're planning to make to drive our success. For the avoidance of doubt, we are in the business of driving growth. [chuckles] This is, like, full stop. That is what we are here to do, and that will require us to take risks, to be willing to fail quickly, to learn quickly, to adapt and evolve quickly, rinse and repeat. I promise the journey won't be dull. I look forward to working with you. Barry".
- BGBen Gilbert
Of course, this is after he opens by talking about how much he loves riding with Matt Wilpers.
- DRDavid Rosenthal
Yes.
- BGBen Gilbert
It is great-
- 1:44:44 – 2:22:03
The debate: bull vs bear narratives, core powers, and Barry’s grade scenarios
- BGBen Gilbert
So it's, like, a pretty cool... There, there's, there's so much crazy lore in the building of Peloton, um, which I think we would've done if we gave this the three-hour treatment. But let's, let's go into our, uh, our narratives. So, like, what's, what, what is the media narrative right now for the bull case and the bear case? Well, uh, on the bull, there's just an insane level of customer love for this company. I mean, the NPS is around 90.
- DRDavid Rosenthal
You're wearing a Peloton hat as we do this. [chuckles]
- BGBen Gilbert
[chuckles] I'm wearing a Peloton hat because I referred you, and they sent me $100 of free credit to buy, uh, gear for myself, which I proudly wear around, and I hope Peloton stays a prestige brand because I've definitely bought a [chuckles] decent amount of the merch. Uh, yeah, even, even if they sell, I, I have to imagine this'll stay a prestige brand for a reasonable amount of time. Like, I won't... It's funny how I feel, like, a little bit weird wearing my SoulCycle, like-
- DRDavid Rosenthal
Mm
- BGBen Gilbert
... shirt and stuff now, 'cause I just haven't been in two years. But the, the Peloton stuff, maybe it says a lot about me, but happy to wear it. Uh, th- so that- a huge component of the bull case is, "Oh, my God, we've built this brand that people love. They love the product. They love the experience." David, after we record, I will probably go hop on for a ride, uh, 'cause we're recording early in the morning, and I missed my morning ride this morning. Uh, another huge component is, uh, say what you want about growth right now, but how could, how could they possibly be worth less than they were worth before COVID? The- they, they grew membership from 700,000 to nearly 3 million.
- DRDavid Rosenthal
And it's not like they're just selling bikes here. This isn't one time. They just added all that subscription revenue with an incredibly low churn rate and high NPS.
- BGBen Gilbert
Yep, totally agree. They invented the connected fitness category, and they're still the largest player in it. Uh, we'll talk about this on power, but there are network effects from your friends having Peloton, so the fact that they grew all these subscribers, you know, there, there, there is some amount of lock-in that comes from that. Uh, the biggest thing we talked about is, um, this insanely low churn rate, and to date, the fact that, you know, they selected for customers that aren't gonna churn, and that, that's slowly shifting, 'cause that's the other side of the sword of selling a product that is cheaper than it used to be, is that you're gonna have customers that are more, more sensitive to price all around, and so are gonna churn, um, more often than your initial cohort.
- DRDavid Rosenthal
Even still, the, the churn has gone up, but it... I think it's gone from, like, uh, I'm gonna get the numbers wrong, but it was at, like, 0.6% per month to, like, 0.8% per month. So, like, it's still good.
- BGBen Gilbert
Totally. I do wanna call out, and this is sort of between a bull and a bear case, but it's just an interesting stat to know. So when Affirm went public, there was, uh, s- some information in their S1, where at the time, Peloton was the largest customer, or the f- the largest source of revenue to Affirm. Now, Affirm has grown a lot and diversified, uh, but I took up the... I, I, took Affirm up on their offer and Peloton up on their offer to finance my bike over the course of a few years, rather than pay for it and cash outright, 'cause it was a 0% deal. S- someone was basically saying, "Do you wanna keep investing your money, and you can pay us once a month over the course of two years and generate some, some money while, uh, you know, you keep the float?" And I was like: Sure, I'll do that deal. That sounds- [chuckles]
- DRDavid Rosenthal
I know how the insurance business works. [chuckles]
- BGBen Gilbert
All day, I will do that deal. And, uh, it's funny th- how much I've thought about this for how little the actual dollars are that, m- that is, like, marginal for me to have done this versus paying cash, but I did. And-
- DRDavid Rosenthal
That's the most Ben Gilbert thing that- [chuckles]
- BGBen Gilbert
[chuckles] ... is possible.
- DRDavid Rosenthal
I love it.
- BGBen Gilbert
But what's interesting is the fact that they offered it at all. So when you look under the covers of why was Peloton willing to offer 0%, or why was Affirm willing to offer 0%? What does that deal look like? Well, Peloton and Affirm did a back-end deal, where Peloton said, "If you agree, Affirm, to do 0% financing, we will pay you an amount in order to make it worth your while. And so you tell us what, you know, that amount is." At the time of IPO, of Affirm's IPO, 28% of all of the revenue in the previous year leading up to the IPO was from the Peloton deal.
- DRDavid Rosenthal
Wow!
- BGBen Gilbert
Which, if I'm doing the math right, based on what their revenue numbers were at the time, that is $150 million a year that Peloton was paying to Affirm to offer this 0% percent financing thing. So that gives you a sense of how much Peloton knows and knew even then, "Oh, my God, we need to expand downmarket because we are saturating our wonderfully price-insensitive-... core customer base or initial customer base.
- DRDavid Rosenthal
Wow! That's, that's huge. And, and the whole, you know, we, we, uh- we're about to release a great LP Show episode with Christina Melas Kyriazi, who, uh, just joined Bain Capital Ventures. She's been a longtime friend of mine, but was an early employee at Affirm, and we talk about, with her, about the whole buy now, pay later space, and that that's the key. You know, the key-- one of the key value props to merchants is this enables sales that wouldn't happen otherwise. But, oh, my gosh, yeah, but, like, I think that's just, uh... You're right, this is between a bull and a bear, but trending into the bear category here. Like, the focus on their core customer is really, like, things have gotten so wonky [chuckles] in the past year-plus.
- BGBen Gilbert
Well, the bear case to make out of that is, like, the, when you look at their demand r- recently, like, the fact that they only grew nine percent in Q4 and five percent in Q1, even though they have this Affirm deal out there, even though they're dropping the prices on their bikes, like, that's the scary thing, is that their attempts to make this more interesting at more price points to a much broader swath of people is, is not really working.
- DRDavid Rosenthal
So, yeah, and I think, unless you have more, I think the last bull case, which I think really is a valid bull case, is like, [chuckles] hey, you know, uh, I don't like to put faith in single people, uh, in general, but, like, I do think there is a lot of, like, fundamental... Like, to my mind, my experience as a customer with Peloton makes me believe that there have been just bad product and marketing decisions over the past year. Um, al- almost, that is, that is not a controversial statement at all. There have a hundred percent been bad product and marketing-
- BGBen Gilbert
Well, and bad, bad strategy, bad financial decisions, bad forecasting.
- DRDavid Rosenthal
You gotta think that Barry can make a huge difference in fixing a lot of these issues. [chuckles]
- BGBen Gilbert
Yes, for sure. I mean, Barry's not gonna be the product person by any, [chuckles] by any means. But, uh, you know, that's why Foley's there, that's why all the great people that they brought on are there. And hopefully, Barry can provide the right sort of... It's almost like the check and balance to make sure that Peloton can do its thing of creating products, and brand, and experiences that people love without screwing themselves over financially.
- DRDavid Rosenthal
Yep. Yep, yep, and the market, the market liked the news. Peloton was up twenty-five percent yesterday.
- BGBen Gilbert
Yeah. Uh, it's kind of a bear case [chuckles] to bring in a CFO, a career CFO, as a CEO. Like, that, that is a strong admission of how in trouble a company is. Um, but I suppose at the, [chuckles] trading down where it is, that makes it a bull case to want to invest, uh, if, uh, if you feel like that person can sort of turn it around.
- DRDavid Rosenthal
Yep.
- BGBen Gilbert
It's definitely not giving Barry enough credit to call him a career CFO, especially given his divisional responsibility in building the ads business at Spotify. But you know what? The right comp might be to Apple when y- they transitioned-
- DRDavid Rosenthal
Hmm.
- BGBen Gilbert
I mean, this was a much different high-flying company at the time of transition, but transitioning from a product founder, you know, product person, who was the founder of the company, as CEO to an operational, financial, supply chain, contractual, legal person. Uh, and it, and, you know, maybe Barry can be the Tim Cook of Peloton.
- DRDavid Rosenthal
Yeah. That's actually a great analogy. Um, I certainly think he's capable, and I, and I think the business is capable. You know, [chuckles] it probably will never be an Apple, right? But I think it's capable of performing better than it is now.
Episode duration: 2:22:03
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