Peloton: Old Hollywood, New Media

Why Hollywood's "studio system" is the future of digital fitness

Hollywood’s Golden Age coincided with a period of technological innovation and the rise of the “studio system”. In this system, leading studios (the “Big Five”) controlled end-to-end content development and distribution. This vertical integration supercharged Hollywood’s growth by enabling studios to profitably scale content development and cultivate star talent.

Is Old Hollywood the future of digital fitness?

Peloton, with its vertically-integrated commercial model, more closely resembles an Old Hollywood studio than a modern fitness company. The company produces content at its studios across New York City; it retains a roster of star instructors; and it controls content distribution via an install base of high-end bikes. As with the Old Hollywood studios, this model enables Peloton—the integrator—to capture incremental value vis-à-vis downstream customers and upstream talent.

With respect to the former, Peloton can capture a relatively larger share of economic value because its hardware, once purchased, facilitates ecosystem lock-in. As previously discussed, this commercial model—high upfront cost and low variable costs—can permanently shift consumption in Peloton’s favor. And given the minimal per-subscriber costs of producing new classes, Peloton can support these loyal customers at higher absolute margins than its competitors.

How does Peloton capture incremental value from upstream talent?

Peloton captures relatively more upstream value than its boutique peers by minimizing the correlation between top line revenue and talent payouts. For example, in the years immediately preceding its IPO, Peloton demonstrated an ability to scale its class-related costs from ~90% to ~60% of associated revenue. In contrast, SoulCycle’s compensation costs held steady at approximately one-third of revenue during the same pre-IPO period.

Peloton achieved this scalable outcome by 1) tying talent’s upside to corporate value rather than top line revenue and 2) signing talent to multi-year employment agreements. By paying talent with salaries and stock options, Peloton transforms instructor compensation from a highly-variable cost to a relatively fixed cost. Stock options ensure that asymmetric upside is tied to corporate success, not individual star power; thus, talent is incentivized to enhance the Peloton brand as well as its own. In effect, this compensation structure enables production costs to scale as the company’s install base grows.

Peloton also facilitates value transfer by adopting the Old Hollywood tactic of long-term employment contracts. Per the company’s S-1:

Our standard employment contract with our fitness instructors has a fixed, multi-year term, however, our instructors may leave Peloton prior to the end of their contracts.

As they did for traditional studios, employment contracts reduce talent churn—an issue endemic to the fitness industry—and better define the payback period for talent-centric capital investments. In doing so, these agreements enable Peloton to more accurately forecast the return on investment for its talent relationships. With this capability, the company can treat talent as strategic assets with quantifiable risk profiles; ergo, Peloton can place more profitable bets on talent.

In short, these two approaches mitigate the strategic and financial risks associated with Peloton’s star-making platform. As a result, the company can capture incremental economic value unavailable to its boutique fitness peers.

How can digital brands compete in this new “studio system” environment?

To compete successfully, emergent players will need to follow the Old Hollywood playbook—now the Peloton playbook—of vertical integration. Only by integrating will these companies capture sufficient economic value to compete with closed ecosystems such as Peloton and open ecosystems such as social media.

A glance at the market suggests near-term opportunities for driving long-term strategic value:

• Technogym: Given Technogym’s large install base, the company should consider upstream integration. Creating a digital content ecosystem, inclusive of new trainers and hardware adjacent modalities such as yoga or strength training, could facilitate greater ecosystem lock-in.

• NEOU/ClassPass: As content aggregators, NEOU and ClassPass should formalize their relationships with talent by signing exclusives that can drive greater customer retention. To ensure greater ecosystem lock-in, these companies should double-down on distribution partners—either corporate distributors or OEM manufacturers—that can position these offerings as the default on-the-road alternatives for everyone.

• Equinox: As Equinox enters the digital space, it must compete in multiple parts of the value chain simultaneously. On the content side, the company should maintain a separate incentive structure for Variis talent that ensures longer-term commitments. On the hardware side, the company should prioritize adoption of its at-home offering, either through discounts to current club members or teaser pricing for those outside the Equinox ecosystem (i.e., Equinox, SoulCycle, Pure Yoga).

What are the long-term implication of this industry structure?

Old Hollywood was not a winner-take-all market. Multiple studios successfully competed year after year for audiences and accolades.

This industry structure will carry over to the digital fitness market, where multiple winners—each catering to different segments and content modalities—will emerge. Only time, however, will reveal which companies emerge as digital fitness’ “Big Five” equivalents.