All companies that go out of business do so for the same reason — they run out of money. — Don Valentine, Founding Partner at Sequoia Capital
This story was originally published on Hustle Fund’s blog.
WeFit, the “ClassPass” of Vietnam, has recently been in the spotlight of the startup community. Founded in 2016 and having raised more than $1mn in venture funding, the startup was once seen as the ecosystem’s poster child. Unfortunately, the startup’s loss-generating business model, coupled with covid-19, resulted in its filing for bankruptcy.
From a macro-level, the recent failures of WeWork and the likes marked the end of the Softbank-funding era. Investors have seemingly lost appetite for supporting startups with negative unit economics through several rounds of funding.
Now more than ever, it’s important for startups to focus on the path of positive unit economics early on.
As an early adopter who has gone through all of the product iterations, I thought it is fitting to do a case study on ClassPass. More specifically, let’s explore how ClassPass has turned their negative unit economics business around to finally join the “unicorn” club in 2020, crossing $1bn in valuation.
Hypergrowth early on at the cost of unit economics
ClassPass was founded in 2013 on the promise of introducing new customers to boutique fitness classes at a deep discounted price.
- Value proposition to users: Get great deals on fitness classes and try out a variety of them
- Value proposition to studio owners: Get new potential customers who will convert to full-priced later
To win market share, an unsustainable business model was quickly launched. For $99/month, users could attend up to 10 classes, paying only $10 for something that would have cost $35 if purchased directly from the studio.
Soon after, the company aggressively built on its early traction and launched the unlimited plan for the same price at $99. In extreme cases where users took one class per day, they ended up paying only $3.30 per class, roughly 10% of the retail price.
Not surprisingly, ClassPass immediately experienced hypergrowth, generating more than 4mn reservations at more than 4,000 studios.
Yet, the operating numbers at the end of 2015 revealed an ugly side of hypergrowth at all costs.
According to a ClassPass internal document obtained by VICE, the company was on the path to an annual gross loss of $65mn in 2016.
The negative unit economics means the company was operating on a finite runway, and without the infusion of new funding, the only way forward was to find a path to profitability.
First pivot: Increase price and get rid of unlimited-class model
ClassPass’ first order of business was to get rid of its unlimited-class package, citing “unsustainable business model.” Instead, ClassPass launched 5-class and 10-class packages for $75 and $135, respectively.
This change was obviously met with frustration and annoyance from ClassPass’ existing customer base.
Even then, the company was still paying their studio partners on average $18 per class. ClassPass was betting on the traditional gym model, where consumers do not take full advantage of their benefits.
Instead, most of the users were taking the maximum number of classes each month, netting ClassPass only $13.50 — $15.00 of revenue per class, or a negative 17% to negative 25% gross margins.
The business model wasn’t working for ClassPass.
Second pivot: Reduce costs of goods sold, increase revenue while enhancing retention through the switch to credit-based model
In 2017, founder Payal Kadakia stepped down as CEO. Chairman Lanman stepped in and rolled out a series of changes, including the launch of the credit-based model.
- Users get a fixed number of credits that can be used however they want, with different classes costing different numbers of credits.
This allowed ClassPass to direct customers to cheaper classes by making them more appealing (costing fewer credits). This effectively reduced ClassPass cost of goods sold while maintaining the same level of monthly revenue. As a result, the company increased their gross margins.
- At the same time, ClassPass also removed the limit on the number of times that a user can visit a studio. In addition, ClassPass negotiated with studio owners for higher payouts for premium classes.
Users effectively paid a higher price to attend these classes, as they took more credits to attend. As a result, ClassPass increased their revenue with customers purchasing additional credits to attend their favorite premium classes. At the same time, more premium options increased customer retention.
The second pivot was a turning page for ClassPass with its gross margins turning from negative to about +5%, according to an internal company document obtained by VICE in 2019.
Final takeaways
ClassPass, once the poster child of fitness-tech startup, has gone through a series of painful pivots to finally achieve positive unit economics. The pivots were not without side effects, impacting both users and partners who are essential to the platform.
On the path to profitability and continuous growth, the potential cannibalizing impact of ClassPass driving down the costs of fitness classes and pushing out some of its studio partners is still to be seen.
However, one thing we know for sure: Without timely pivots to turn negative unit economics to positive, ClassPass would have suffered the same fate as WeFit back in 2015.
Instead, ClassPass managed to raise $285mn in January 2020, becoming the first unicorn of the decade. The infusion of capital was timely enough to help the company weather through covid-19 shutdown and transitioning to online classes.
Now more than ever, it’s important for startups to focus on the path of positive unit economics early on.