Peloton lost $187 million in one quarter (here's why)

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Welcome to the Income Ivy Newsletter.

Think you know what part of your business customers actually value?

Companies get this catastrophically wrong all the time. Here's something that might shock you: Peloton lost $187 million in one quarter in 2022 trying to force customers to buy expensive hardware when they actually wanted the classes and community.

The company thought customers needed the $2,000 bike to get the Peloton experience. Turns out, people just wanted access to the instructors and the tribe. The bike was the package, not the product.

When competitors offered the same classes for any bike at a fraction of the price, Peloton's entire model collapsed. They'd confused what customers valued (content and community) with what they sold (premium hardware).

The wildest part? Three of the most successful companies in modern business nearly destroyed themselves making this exact same mistake. And most entrepreneurs are making smaller versions of it right now without realizing it.

Peloton's hardware prison

John Foley built Peloton around a simple idea: premium connected fitness bikes with live streaming classes. The business model seemed obvious. Sell expensive bikes, add a subscription for classes.

For years it worked beautifully. Revenue exploded. The company went public. Market cap hit $50 billion at its peak in 2021.

Then the pandemic ended and reality hit. Cheaper competitors like Echelon offered similar classes that worked with any bike. Apps like Apple Fitness let people do the same workouts without buying anything.

Customers started asking uncomfortable questions. Why pay $2,000 for a bike plus $44 monthly when they could pay $15 monthly and use their existing equipment? Was the Peloton bike really worth 133x more than the digital-only option?

The answer became clear: No. Most customers valued the instructors, the music, the community, and the motivation. The bike was just one way to access those things, not the thing itself.

Peloton eventually launched a cheaper digital-only membership, essentially admitting the bike wasn't the core value. But the damage was done. The stock crashed from $167 to under $10. The company laid off thousands. They lost $187 million in Q3 2022 alone.

All because they confused the package (hardware) with the product (content and community).

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Starbucks' automation nightmare that never happened

Here's one from earlier: In the mid-2000s, Starbucks faced serious problems. Same-store sales were declining. Growth was slowing. Wall Street pressured them to cut costs and increase efficiency.

The obvious solution seemed to be automation. Install automatic espresso machines that would make drinks faster and more consistently. Reduce labor costs. Speed up service. Improve margins.

Howard Schultz, who had stepped away as CEO, watched this strategy with growing alarm. He saw the company preparing to eliminate the human barista experience that made Starbucks special.

In 2008, Schultz returned as CEO and immediately reversed course. He realized Starbucks wasn't selling coffee. They were selling the third place between home and work where baristas knew your name and made your drink exactly how you liked it.

The coffee was the package. The human connection and personalized experience were the product.

Automating everything would have been cheaper and faster. It also would have destroyed what customers actually valued. The imperfect, human interaction was the point, not a bug to fix.

Schultz shut down every U.S. store for a day to retrain baristas. He focused on experience over efficiency. Starbucks recovered and grew to over 35,000 locations worldwide with a market cap exceeding $100 billion.

They almost killed themselves by optimizing the package while destroying the product.

Netflix's DVD rental trap

Netflix started in 1997 mailing DVD rentals to customers. No late fees. Huge selection. Convenient home delivery. The model crushed Blockbuster.

By the late 2000s, Netflix dominated DVD rentals with millions of subscribers. The company printed money from disc-by-mail subscriptions.

But Reed Hastings understood something crucial: Customers didn't want DVDs. They wanted entertainment on demand. DVDs were just the best available delivery mechanism at the time.

In 2011, Netflix made a bold, almost suicidal move. They split the business, raising prices significantly and trying to separate DVD rentals (Qwikster) from streaming (Netflix).

The execution was terrible. Customers revolted. Netflix lost 800,000 subscribers. The stock crashed 77%. It looked like a catastrophic mistake.

But the strategic insight was correct. Hastings knew that if Netflix stayed focused on DVDs (the package), streaming competitors would destroy them. The product was on-demand entertainment, not disc delivery.

Netflix pivoted hard into streaming despite short-term pain. They invested billions in original content. They abandoned the DVD business that had made them successful.

Today Netflix has over 260 million subscribers globally and dominates streaming. The DVD business, which seemed like their core product, became irrelevant. They survived by recognizing the package versus product distinction before competitors did.

The package versus product trap

Here's what these three learned the hard way: Customers hire products to solve problems or fulfill desires. The specific mechanism often matters less than you think.

Peloton thought customers needed their bike. Really, customers needed motivation and community.

Starbucks thought customers wanted coffee efficiently. Really, customers wanted human connection and routine.

Netflix thought they were a DVD company. Really, they were an entertainment delivery company.

The companies that survive are the ones that identify the true product before competitors do.

Why smart people confuse package and product

Revenue sources create blind spots
When hardware or DVDs generate most of your revenue, it's natural to think that's what customers value. But revenue source and value source aren't always the same.

Operational complexity obscures value
Peloton spent years perfecting bike manufacturing. That investment created attachment to hardware that customers didn't share. Your operational focus often differs from customer priorities.

Competition reveals true value
You don't know what customers actually value until competitors offer it differently. When apps delivered Peloton classes without the bike, the truth became obvious.

How to identify what customers truly value

Watch what they'll pay to avoid
Peloton customers would pay $2,000 to avoid going to boutique fitness studios. The product wasn't the bike. It was convenience and privacy. What pain is your offering really eliminating?

Test unbundling
Peloton's digital-only membership revealed most customers valued content over hardware. What happens if you strip away 80% of what you sell? Do customers still buy?

Study customer behavior during disruptions
When the pandemic ended, Peloton demand collapsed but fitness class demand didn't. Disruptions reveal what customers actually need versus what was just convenient.

Look at which features customers never use
If your "essential" features go unused, they're not the product. They're packaging you think matters more than it does.

The most expensive mistakes in business come from confusing what you sell with what customers buy. The package is your delivery mechanism. The product is the value customers actually want.

Peloton sold bikes but customers bought community. Starbucks sold coffee but customers bought connection. Netflix sold DVDs but customers bought entertainment.

What's your package and what's your product?

Emil | Founder of Income Ivy