Peloton says only 0.65% of its subscribers cancel each month. Here's why customer retention experts think that number 'doesn't pass the smell test.'
- Peloton, in the paperwork is filed for its initial public offering, touted data that indicates that very few of the subscribers to its fitness video service cancel each month.
- The company's churn rate - the portion of customers that cancel in a given period - appears to be far lower than that of Planet Fitness or even Netflix.
- But its churn numbers shouldn't be taken at face value, customer retention experts said.
- They're likely understated due to a number of factors, including the huge number of subscribers it's been adding and long-term subscription deals it used to offer to its customers.
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Peloton wants potential investors to know its customers love its fitness service so much, that few of them ever give it up.
But experts in customer retention think there's more to the story than the company is saying.
The debate centers on something called churn, which is a term for the portion of a company's subscriber base that cancels service during a given period. Although Peloton is known for its fitness equipment, it also offers a subscription service that streams live and recorded workout videos to screens on those devices. The subscription service allows it to stay connected with its customers - and provides it with an ongoing revenue stream - after they purchase its equipment.
According to data in the paperwork Peloton's filed this week for its planned initial public offering, it has remarkably low churn, which could bode well for the long-term prospects of its business.
"Our compelling financial profile is characterized by high growth, strong retention, recurring revenue, margin expansion, and efficient customer acquisition," the company said in its IPO paperwork. "Our low Average Net Monthly Connected Fitness Churn, together with our high Subscription Contribution Margin, generates attractive Connected Fitness Subscriber Lifetime Value."
But customer retention experts think Peloton's churn rate is understated in multiple ways and in the future will likely be significantly higher than it is now. Churn rates are commonly reported in the fitness industry, but they're not a particularly meaningful measure of customer value, said Paul Bedford, a principal at Retention Guru, a consulting firm that helps health clubs improve customer retention.
"I wouldn't invest any money based on that [churn] number," Bedford said. He continued: "When I see that number, I just disregard it ... It's a vanity metric."
Peloton's churn rate is far lower than Netflix's
Peloton offers two different subscription services: one that's targeted at people who own one of its fitness bikes or treadmills, for which it charges $39 a month, and one that designed for folks who don't own any of its equipment, for which it charges $19.49. The churn rates it discloses are for the former - for people who own its equipment, which it calls its "connected fitness subscribers."
In its IPO filing, Peloton reported that it had a churn rate of just 0.65% per month in its most recent fiscal year, which ended in June. That rate was up slightly from fiscal 2018, when its churn was 0.64%, but down from fiscal 2017, when its rate was 0.7%.
The churn rate Peloton posted in its most recent year works out to be a little less than 7% on annual basis. That's an extraordinarily low figure. Planet Fitness, which operates a chain of gyms, has an annualized churn rate of 18% to 30% - and far higher than that in the first few months after people sign up for a membership, according to a recent report in The Wall Street Journal. Meanwhile, Netflix, long the paragon of a successful digital subscription business, has a churn rate of around 9% a quarter - or about 36% a year - the Financial Times estimated last year, citing several different studies.
Peloton thinks the churn figures are so important that it touts them on the second official page of its filing and talks about its low churn rate some 27 other times.
"Usage drives value and loyalty, which is evidenced by our consistently low Average Net Monthly Connected Fitness Churn," it says in one section of the document. "Our unit economic model benefits from low Average Net Monthly Connected Fitness Churn and high Subscription Contribution Margin," it continues in another section.
But Peloton's churn rate shouldn't be taken at face value, retention experts said.
Its churn rate "doesn't pass the smell test"
By dividing 1 by the churn rate, you can get a rough estimate of how long the average customer sticks with the service before cancelling, said Daniel McCarthy, an associate professor of marketing at Emory University's Goizueta Business School. Doing that calculation with Peloton's customer churn rate implies that the average customer would stay with its service for about 154 months or nearly 13 years, he said.
That's almost twice as long as Pelton has been in existence. It's also far longer than its equipment is likely to last, McCarthy said. And when their bikes or treadmills breakdown, some customers may replace them, but others won't and will likely cancel their service.
The churn rate Peloton gave "doesn't pass the smell test," McCarthy said.
Indeed, Peloton's filing makes clear that the churn rate is almost certainly understated.
For example, the company allows customers to pause the subscription service for as long as three months. But it continues to count those customers as active subscribers even while their subscriptions are paused. Such customers may not have churned yet, but they aren't paying company any money either.
Peloton didn't disclose what portion of its connected fitness subscriber base - which hit 511,202 at the end of June - had paused its subscriptions. Nor did it reveal what portion of those that paused their subscriptions cancelled them right after that interruption of service.
But there's likely a bigger factor at play with Peloton's churn rates. Up until July of last year, the company offered customers the chance to sign up for extended subscription agreements. Customers could sign up for one or two years of service and get anywhere from one to three months for free. Alternatively, customers who used Peloton's financing service to purchase their equipment could include with their purchase a prepaid subscription lasting anywhere from one year to 39 months.
The company didn't disclose how many of its customers are still on those extended subscription plans. But it did say it will still have some customers on them into its 2022 fiscal year. Peloton includes those customers when calculating its churn rate. That's a bit misleading, because it means the churn figure includes people who haven't really had the opportunity to leave yet, Bedford said.
"Why would you leave after you prepaid [for the service] with a great deal?" said Joel Shapiro, an associate professor of data analytics at Northwestern's Kellogg School of Management. "When you talk about churn rate being low," he continued, "you sort of assume that the people in the calculation should be those that actually, arguably, could churn. And when you have somebody who's under contract for two more years, it arguably doesn't make any sense to include them in the calculation."
It's quite likely that as those long-term deals expire, Peloton will see a spike in its churn rates, retention experts said. The company might well be seeing an uptick in subscription cancellations now, one year after it stopped selling its one-year plans, Bedford said.
"There's a whole bunch of people who are coming to the end of the subscription period who may not renew," he said.
New subscribers are likely distorting the picture
Another factor that's likely helping Peloton minimize its churn rate is just the sheer number of new subscribers it has been adding. The number of people subscribing to its connected fitness service more than doubled in each of its last two fiscal years, going from 107,708 in June 2017 to 245,667 in June 2018 to more than 500,000 this past June.
Because the churn rate is derived in part from the number of overall subscribers a company has, even if it's losing a large number of subscribers, the rate can look low if it's consistently adding many more.
"Their [churn] numbers in the early years you would expect to be low," said Dave Rochlin, the executive director of the Innovation, Creativity, and Design Practice at the University of California, Berkeley's Haas School of Business.
What's more, new subscribers are often less likely to cancel a service, because they tend to be the most enthusiastic customers, Rochlin That's particularly true with Peloton, because it's new subscribers have just spent - or are in the process of spending - thousands of dollars on its equipment, he said.
"If you think about the size of investment you're making on that piece of equipment, it's pretty likely you're not going to turn around and cancel service right away," Rochlin said.
That doesn't mean that Peloton has a bad business or that it's done anything wrong in calculating or presenting its churn rate, the retention experts said. But it does mean that investors shouldn't be surprised if that rate starts to tick upward in the near future.
Because of the factors that seem to be playing a role in keeping Peloton's churn rate low, "this all feels a little bit like a game that's being played," Shapiro, of the Kellogg School, said.
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- Read more about Peloton's IPO:
- Peloton, the buzzy exercise-bike startup that ignited the connected-fitness craze, has filed for an IPO and revealed spiraling losses
- Peloton insiders will have 20 votes per share - twice as many as those at other startups - but CEO John Foley may not wield all the power after the IPO
- Peloton is paying its two top execs $21.4 million apiece, even as its losses quadrupled to $245 million in its most recent fiscal year
- In its IPO documents, Peloton warned it's got some particular shortcomings as a business that could lead to fraud or financial restatement