What’s Wrong With Fitbit
Last week, Fitbit lost $838M in market cap as its stock price plunged 35%. Worse yet, FIT is down an astounding 73% since its peak a few months ago. What is going on with this once high-flying company?
To answer this question, I reviewed Fitbit’s operations and the market in general. In order to evaluate whether or not Fitbit’s operations were robust, I needed a baseline for comparison. For that, I chose Fitbit’s closest competitor’s, Garmin Ltd.’s Fitness division.
Below is a chart showing each company’s offerings. There are three important differences to highlight. First, you will notice that Garmin has a far larger portfolio of sports watches. Garmin’s heritage in running watches spans more than a decade and it is the world leader in GPS watches for endurance athletes. This deep experience in running can and is leveraged by its other fitness offerings. Second, Garmin also has a full range of cycling products, while Fitbit has completely eschewed this market segment. Third, Fitbit’s pricing across the board is significantly lower–more than 20%– than Garmin’s.
It is no coincidence that Fitbit’s share price is plummeting at the same time that its operating margins are falling.
Fitbit’s revenues are basically 2.5x larger Garmin Fitness’; however, the reverse is true for the operating margin.
The graph below illustrates that Fitbit’s gross profit margin (gross revenue minus cost of goods sold) is steadily declining. This is one of the reasons that the operating margin is low, yet there are several more.
Another key contributor to Fitbit’s low operational profit is its manufacturing woes. As Fitbit expands into smaller, more complex devices, the manufacturing requirements get increasingly more difficult. This difficulty is exacerbated by Fitbit’s reliance on Flextronics to manufacture its products. For example, this summer there was a major manufacturing problem with the first manufacturing run of the Flex 2, that forced the company to scrap several million dollars worth of parts and lead to the loss of $50M potential sales for product that never reach the marketplace.
In contrast, Garmin is one of the few consumer electronics companies that actually builds its own products from design to prototype to assembly. It does so via its company-owned and -staffed plant in Taiwan. All told, Garmin has hundreds of employees dedicated to manufacture; Fitbit has 80.
R&D expenditure also plays a role in operating margin. Fitbit is outspending Garmin Fitness by 4x. In relative terms, Fitbit’s R&D as a percent of revenue is 16% vs. Garmin Fitness’ 9%. This is a bit of an unfair metric because Garmin Ltd. as a whole spends 17% of revenue on R&D. Of course, all of that is split amongst its 5 divisions so some of that R&D spend in other divisions is finding its way it the Garmin Fitness product line. Still, it is remarkable Fitbit invested $289M in R&D for the past 12 months, while Garmin Fitness only spent $63M…and had to support 3 additional product lines- Edge, Varia, and Vector.
The next component of of the operating margin is advertising. Here, too, Fitbit is outspending Garmin Fitness by a 3-to-1 margin. On a relative basis; however, the two companies are nearly identical 13% of revenue vs. 12% of revenue.
Summary of Operations
When you sum up all these components, its clear that Garmin Fitness has a decided advantage over Fitbit. In order to overcome this handicap, Fitbit needs substantial product differentiation. The problem is that Garmin is actually closing the gap.
Activity Tracking Market
Looking beyond operating margins, there is another key fact that is haunting the San Francisco company:
Fitbit is losing market share just as the market growth is slowing.
Market share is dropping because all the competitors are close to parity with respect to product design and capabilities. Everyone is making activity trackers that count steps, estimate calories burned, measure heart rate, and analyze sleep. Fitbit used to do these things better and more stylishly than the competition did, but that is no longer the case.
While the activity tracker market does continue to grow, that growth rate is slowing. There are numerous reports that show many consumers stop using their activity trackers after a few months, so replacement sales are difficult. Furthermore, there is a major gap between collecting data and making it useful. It is one thing to get accurate measurements; it is quite another to make life-improving behavioral changes based on that data. Until this gap is bridged, many would-be customers will continue to question the value of activity trackers as anything more than a novelty.
The question for its shareholders is whether it can rebound or will it become this decade’s Palm?