One of the features of Fitbit’s bands is the step counter is reset everyday. You are assigned an arbitrary default goal of 10,000 steps a day and you are measured on how you do on this goal. You cannot bank the excess steps from one day to another, nor is there a moving average (no pun). Fitbit investors seem to me treating its performance in exactly the same way – what can you deliver next quarter, no matter you crushed the current quarter. Despite beating consensus estimates on units and revenue its stock dropped 16% in off-hours trading due to its bad outlook for next quarter. It is getting a taste of its own medicine – does not matter you walked 60,000 steps today, can you walk 10,000 tomorrow?
The problem is actually lot more than this simple explanation of what is ahead in the next quarter. It is the realization of its market dynamics, product strategy, gross margin concerns and cost of growth.
Market Dynamics: It is tempting to define the market as fitness and personal training. If we look through that lens there is not a significant customer spend for fitness alone and definitely not enough to spend $150 to $250 for a band. Just like fitness products and behavior changes the sales are seasonal and habits are fleeting. When it comes to fitness we jump from one fad to another quickly. If it is a disposable product with fleeting usage there are far cheaper options available. In fact there is virtually no barriers to entry for any new player to enter this category. The components are standard and mass produced and the software is not insurmountable.
If we expand the market as smartwatch with fitness features added, that space is warped by the biggest black-hole Apple that pretty much sucks every customer dollar in the disposable income bucket. Fitbit lacks the wherewithal to enter this market or the investment dollars to compete against Apple’s ecosystem.
Product Strategy: Fitbit’s product strategy seems to be hit driven with single product delivered as multiple versions. It is trying to add accessories revenue by appealing to style sense with multiple fashionable bands for the devices. You can see the futility of that model when customers abandon the bands just after few months of usage. It is launching a stylistic band called Fitbit Alta priced at $149 and a smartwatch priced at $200. Alta does not have Heart Rate Monitoring (HRM) like its other $149 model Fitbit HR and hopes to appeal to style sense over health monitoring. That strategy has been called into question. And its Blaze faired very badly in product reviews. In essence a very shaky or non-existent product strategy and pipeline.
Gross Margin Concerns: The Average Selling Price (ASP) has been hovering around $86-$87 range. That implies its current $250 product is not finding any takers and its $149 retail priced bands are sold to retailers at much lower price. For the coming quarter Fitbit will not have many days to sell its new $200 Blaze or the stylistic $149 Alta. With considerable inventory built up for older models, retail channels filled with those, and customers waiting on sideline for the newer models Fitbit has to run price promotions this quarter. BestBuy has already slashed price by up to $30. All these factors explain the low 46.5% gross margin that Fitbit is forecasting for this quarter. Investors can see this is a repeatable pattern due to its week product strategy. With ASP stuck at $87 and no traction for its smartwatch there is no visible path for higher gross margin in the future.
Cost of Growth: Fitbit made its story all about growth and posted triple digit units and revenue growth past few quarters. While that makes sense in early stages of the market it does not carry over in fitness or fashion category. If 50% of users abandon after few months and only a smaller share of who is left upgrade every two or three years, Fitbit can post growth only by continuously acquiring new customers. Investors are growing tired of growth at any cost companies and in this case there is no magic switch Fitbit can turn on to suddenly make more profit from all its growth.
It should not surprise that finally its valuation is catching up to this reality after the initial euphoria.