How Fitbit Inc. Can Still Thrive Even With High Abandonment Rates

Source: Fitbit.

After topping out at nearly $52 earlier this month, Fitbit has took it particularly hard amid the broad market sell-off last week, down over 25% from that high. The market seems to be in one of those "risk off" moods, where investors ditch relatively speculative investments and flock toward safer returns. That puts hyped up IPOs near the bottom of the list, creating significant selling pressure.

However, this is a legitimately negative storyline brewing for the maker of the popular activity tracker: Fitbit has something of a problem with high abandonment rates. The latest data points to support this theme come from Robert W. Baird & Co. the firm released a survey last week gauging consumer demand, adoption, and usage. Do you want the good news first or the bad news?

Let's start with the badFitbit buyers go through a bit of a honeymoon phase. Shortly after purchasing, a healthy 62% of users regularly use their fitness trackers. But as time goes on, which it inevitably always does, that usage declines as people lose interest and/or motivation.

A discouraging 28% of users stop using their devices over time, and after two years that figure jumps to 46%. While Fitbit tells investors not to read too deeply into its active user metrics as it relates to engagement, you can't ignore the fact that 46% lines up uncannily to the percentage of active users to registered users, which was 50% in the first quarter.

The ongoing fear here is that fitness is simply a tough sell for the mainstream consumer.

OK, give me the good newsFitbit is not alone here. The relatively high abandonment rates are common for the fitness industry. Everyone wants to get in better shape, but not everyone follows through. It's a categorical fact. Look at the seasonality of gym memberships after a majority of the New Year's crowd gives up.

Baird has some encouraging data points as well. For instance, 22% of respondents in the U.S. have purchase intent, and Fitbit is the leading brand among those by a large margin. Coincidentally, only 22% of U.S. consumers currently own a fitness tracker, suggesting that adoption remains relatively low and that there are plenty of opportunities going forward.

All markets have phasesHere's where it gets good though. So right now the activity tracker market is very much in the adoption phase, as consumers give the new product category a try for the first time. Sure, a large portion of those adopters will give up on the product, but during the adoption phase of any nascent market the rising tide lifts all boats. Fitbit will inevitably be the greatest beneficiary during this phase.

Yet, Fitbit's business is currently reliant on hardware sales. The company is trying to diversify its revenue streams but for now, it's all about selling more trackers. That means that over time, Fitbit's business will rely on ongoing upgrade cycles for recurring sales. As the market matures, some of the adopters will fall off, but there will always be an addressable market of fitness enthusiasts that isn't going away anytime soon. This subset may be a niche compared to the mainstream, but chances are it's a very passionate niche that's willing to invest in fitness.

Moving on upThis is how Fitness can thrive over the long-term even with high abandonment rates. Even more encouraging, Fitbit is already moving upmarket with higher-end devices. Last quarter, Fitbit said that nearly 80% of revenue came from the three most expensive products in the lineup that were launched within the past year, the Charge, Charge HR, and Surge. As the product mix shifts higher, average selling prices and margins tag along for an uplift.

ASPs have been on a steady rise as Fitbit moves upmarket. Source: SEC filings.

Fitbit will gladly sell a device to anyone, even if that person ends up abandoning the product. But over time, I would expect Fitbit to focus its efforts on this crowd of enthusiasts where it can very likely count on recurring upgrades to premium products with higher margins. Even though smartwatches pose an existential threat, the line between high-end fitness trackers and smartwatches gets blurrier every day.

Fitibt had just 9.5 million active users during the first quarter. Consider the possibility that in coming years, Fitbit grows its active and engaged global user base to 100 million, even with 50% abandonment rates. You can build a very successful business addressing a user base of this size, especially if you have strong product cycles that spur upgrades. It's completely feasible.

As for valuation, that's an entirely different question altogether. Fitbit has the foundation of a sustainable business, but 6.8 times sales is still a lot to pay without knowing how the activity tracker market will play out in the years to come.

The article How Fitbit Inc. Can Still Thrive Even With High Abandonment Rates originally appeared on

Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.