This Half-Built Factory Shows HowPeletonMismanaged the Pandemic

BySharon Terlep

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Updated May 21,202211:17 am ET

In a northwest Ohio industrial park, up the highway from a newAmazon.comInc. warehouse and a soon-to-open solar-panel plant,Peloton InteractiveInc.PTON-7.67%is building a million-square-foot factory that it will never use.

The once-hot stationary bike maker is selling the facility, initially set to cost $400 million and to be completed this fall, as it races to downsize a manufacturing operation expanded by leaders who believed Covid-drivendemand would outlive the pandemic.

Its miscalculation about demand and the shift in the market have been so costly that Pelotona company worth nearly $50 billion about a year agohas laid off thousands of people, had to borrow $750 million tohead off a cash crunchand is exploring asale of a minority stake. It is a reminder that strategic choicesnot just pandemic forcesdetermine how businesses emerge from the crisis. Peloton's value fell to less than $5 billion this past week.

In late 2020with homebound consumers clamoring for its bikesPeloton's co-founder and longtime chief executive,John Foley, dismissed the idea that the company was growing too much based on a demand spike that could prove temporary.

"Overbuilding supply-chain capacitythat's a term that has never come up in the Peloton senior leadership rooms or boardrooms," Mr. Foley said in a September 2020 call with analysts. "We feel like there's such a massive opportunity that we need to invest heavily in the supply chain for years and years to maintain it. When yousay'normalize coming out of Covid,' we don't see that."

Officials broke ground on Peloton'sLuckey, Ohio, manufacturing facility lastyear.PHOTO:OFFICE OF GOV. MIKE DEWINE

Many companies faced the same question during the pandemic: How best to handle a surge in demand?Procter & GambleCo. decided not to permanently expand toilet-paper factories that would have taken years to come online.CloroxCo. added capacity through contract manufacturers. To fillgovernment orders for masks,Honeywell InternationalInc. and3MCo. added shifts or retrofitted facilities.

Most of the leaders of those businesses realized that the sudden demand could beshort-lived, orhedged their manufacturing investments.

Peloton chose to build permanent production capacity, believing that demand for its products would remain elevated for years and it could avoid ocean shipping logjams by operating U.S. sites. It struck a $420 million deal to buy Precor Inc., a maker of commercial exercise equipment with two U.S. factories. Then it announced plans for the Ohio factory. Itwas a major strategy shift for a brand that until then had largely relied on third-party manufacturers in Asia.

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Though millions more people now subscribe to Peloton's online workout classes than before the pandemic, sales of equipment have fallen 40% from a year ago. The company recently said weak sales and losses will continue this year.

Even without the Ohio factory, Peloton is laying off hundreds of workers and is saddled with a glut of unsold inventory. It's a sharp reversal from June 2020 when Peloton had $230 million in backlogged orders for its products.

Peloton sales surged in the early months of the Covid-19 pandemic, then fell back to earth as consumers returned togyms.PHOTO:JOHN SMITH/VIEWPRESS/GETTY IMAGES

Barry McCarthy, a formerNetflixInc. and Spotify Technology SA finance executive who took over as Peloton's CEO in February, said the falloff in demand was foreseeable.

"I don't care particularly why they thought that Covid was the new normal, except insofar as to inform me who should be on the bus," Mr. McCarthy said in an interview earlier this year, referring to his executive team and how he'll decide which leaders he'll replace. He has since brought in new executives to oversee Peloton's supply chain.

Mr. Foley, who remains executive chairman of Peloton's boardafter stepping down as CEO, declined to comment though the company. His co-founder, William Lynch, has resigned aspresident and is leaving the board. A Peloton spokesman declined to discuss the leadership's thinking around the manufacturing expansion plans.

Peloton's bikes and treadmills are equipped with a tabletlike screen that connects users to online workout classes. An instructor leading a spin class from a Peloton studio can remotely adjust the resistance on bikes connected to the class.A number ofPeloton instructors have achieved celebrity status among users, some of whom opt to pay a lower subscription fee to access Peloton classes using standard stationary bicycles. Peloton's original bike, which initially sold for $2,245, now costs $1,445 after price cuts. The company last month raised the price of its connected workout subscription, which syncs with Peloton classes, to $44 a month, from $39 a month. A Peloton class membership that's not connected to the equipment costs $12.99 a month. Home stationary bikes from other manufacturers can cost anywhere from less than $1,000 to several thousand dollars.

Headed into the pandemic, Peloton, which Mr. Foley co-founded in 2012, was losing money but notching steady growth. The U.S. outbreak of Covid-19 in early 2020 sent sales surging almost instantly. For the period ended June 30 of that year, subscriber growth more than doubled from the previous quarter and revenue for the company's bikes and treadmills nearly tripled from the year before. Peloton was profitable for the first time.

Peloton's co-founder and longtime CEO, John Foley, center, was a strong proponent of the idea that increased demand would outlast thepandemic.PHOTO:MICHAEL NAGLE/BLOOMBERG NEWS

The good times were short-lived. As demand soared throughout the year and a second Covid wave derailed Americans' hopes of a quick return to normalcy, Peloton became overwhelmed by a crush of orders, which was exacerbated by massive port delays in Asia, where Peloton built its machines. Mr. Foley assured customers and investors that the company was keeping up. But behind the scenes, Peloton was in chaos. Customer-service operations were overwhelmed as people who were paying thousands for their machines faced monthslong waits and repeated, last-minute delays.

In November of 2020, Mr. Foley apologized and said that Peloton was underperforming. A few months later the company said it would delay the launch of a new treadmill, double its customer-serviceoperationsand begin shipping products by air. Peloton acquired Precor and, in early 2021, announced plans to build the Ohio factory.

That summer, with Covid vaccines widely available and gyms starting to reopen, Peloton lowered the price of its bike by about 20%, though it said the cut didn't reflect weaker sales. Three months later, Peloton scrapped its annual forecast while reporting its smallest quarterly subscriber gain since it became a public company.

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Peloton would miss its quarterly forecast everyquarterthereafter, including in Mr. McCarthy's first partial period as CEO.

"Routinely companies get caught in this, building too much and then having to write off inventory and do fire sales," said RaviAnupindi, a University of Michigan professor who studies supply chains. The pandemic, with its drastic demand spikes, exacerbated that phenomenon, he said. "Companies see an increase in demand and become overly enthusiastic, and that's the critical mistake."

Clorox doubled production of some of its most in-demand products, like sanitizing wipes, but stopped short of adding a factory. Rather it enlisted outside manufacturers, hired temporary workers and added lines to existing factories,CEO LindaRendlesaid.

Peloton's new CEO, Barry McCarthy, took the reins when his predecessor, who had pushed for the expansion, steppedaside.PHOTO:ANGELA OWENS/THE WALL STREET JOURNAL

Now Clorox, whose sales slid 7% in the second half of 2021 compared with the same period a year earlier, is reducing overtime and ending contracts with outside manufacturersbut isn't stuck with extra capacity, she said.

P&G andKimberly ClarkCorp., which make Charmin andCottonelletoilet paper, respectively, opted against major capacity expansions as Americans panicked in the spring of 2020 andshelves went bare. As the nation's toilet-paper shortage became fodder for late-night talk show hosts, P&G CEOJon Moeller, then the company's finance chief, said machinery required to make toilet paper was too costly and took too long to build to justify adding more for a demand spike that was unlikely to last. The company took steps to increase toilet paper productionin other ways, including running factories 24/7 and bringing idled machinery back online, to meet demand.

Early in the pandemic, Honeywell set upnew N95 mask production linesat existing facilities in Phoenix and Rhode Island. Those expansions created more than 1,000 jobsand were funded in part through government contracts.

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With the contracts completed and demand for the masks down, Honeywell was left with excess capacity a year later. The company stopped production at the sites and laid off about 500 workers in Rhode Island and 700 in Phoenix about a year ago.

At another site in Chandler, Ariz., Honeywell set up a new N95 production facility early in the pandemic and revamped that site with automated equipment in 2021 to cut production costs in half. Honeywell is in the process of shutting down that facility this year, laying off another 120 people.

Leaving the new manufacturing lines in places didn't make sense, CEODarius Adamczyksaid in July 2021, because they were built with speed in mind. "We did that because the country needed us to do it. We didn't do it to maximize profit," he said on a conference call.

Earlier this year, Honeywell sold some of the manufacturing equipment at auction.

Montreal-basedMedicomGroup, which makes surgical masks in Georgia, said its expanded facilities there are still operating at high capacity because of its longstanding relationships with dental customers and medical distributors.

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Chief Operating Officer GuillaumeLaverduresaid some newer mask-making competitors have shut down because they were too reliant on demand that existed only at the peak of the pandemic. "The factory is running at full speed, as we speak," he said.

Back in Ohio, state and local officials had cheered Peloton's expansion there. The plant was to add 2,000 jobs to the region. A company spokesman said the factory is now expected to cost $90 million to $100 million since Peloton isn't equipping it with machinery.

The state has seen an influx of companies building manufacturing and other operations there, both to meet surging demand and to address problems caused by global supply-chain snarls. A number of U.S. companies, like chip makerIntelCorp., have opted to addsuppliers and production facilities in the U.S.

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Last year,First SolarInc., the biggest American-owned solar-panel maker, announced plans to build a $680 million factory about 10 miles from the Peloton site. Amazon built a fulfillment center nearby, following through on plans made before the pandemic.

Peloton expects to sell its factory inLuckey, Ohio, after construction isfinished.PHOTO:BRIAN DAY FOR THE WALL STREET JOURNAL

Peloton's reversal was a disappointment, said J.P.Nauseef, CEO ofJobsOhio, an economic development nonprofit, adding that the blow is lessened by the fact that the company will finish building it and find a buyer.

"I felt for the team and the people who would lose their jobs," said Mr.Nauseef. "But given the circumstances it's about as good a situation as you could have anticipated."

ThomasGrytaand Austen Hufford contributed to this article.

Corrections & Amplifications Peloton expects the factory it is building in Ohio to cost $90 million to $100 million. A photo caption in an earlier version of this article said the company was spending $400 million to build the factory, a figure that reflected the company's initial projection. (Corrected on May 21)

Appeared in the May 21, 2022, print edition as 'Peloton's Big, Busted BetOnManufacturing'.

Questions:

1.Why did Peloton initiate the construction of a production facility in Ohio, and why is it now planning to sell the facility once it's built?2.What did Peloton forecast would happen to consumer demand for its products following the pandemic? Why?3.Whatactually happenedwith consumer demand for Peloton's products following the pandemic?4.Compare and contrast how other companies adapted to increased consumer demand for their products during the pandemic vs. Peloton.5.What lessons can be learned from Peloton's experiences?