How Behavioral Biases Crushed Peloton’s Business

Peloton did amazingly well during the pandemic. Now the company is facing financial hardship and changing their business model. They will likely survive, but damage to their business and future growth have been significant. So, what what wrong, and why?

The Rise and Fall

As the pandemic forced people to remain indoors and gyms throughout the world were closed, many people sought to continue their fitness, or at least have something to do, by purchasing in-home equipment. Peloton was at the right place at the right time and had the right offering. Sales exploded.

Every business needs to project what the future may look like, and this is where many businesses get in trouble. Especially when unconscious behavioral biases influence our decisions.

Perhaps the two strongest biases in play here were the recency and representativeness bias. And perhaps a little of the endowment bias.

Biased Assumptions

Peloton executives projected that the shift to in-home exercise would persist even after the pandemic. In other words, the recent past strong sales and shift in consumer behavior would be a durable change, and not just a response to restrictions due to the pandemic. Such assumption assumed that what happened recently was representative of what would happen in the future.

The assumption was that people would not return to gyms and would be fine getting their sociality from virtual classes, live or recorded. Perhaps for some that is the case, but we are seeing that many are opting to return to the gym. As we know, being in person truly is a lot different than being virtual.

It was also in Peloton’s best interest to project that consumer and exercise behavior would have changed permanently. So there may have been a bit of an endowment effect influencing such assumptions…they would personally benefit if those assumptions were true. But the bottom line is that they were wrong, and the company is paying a price for it – in sales, market value, and changing their offerings.

Peloton is not Alone

Making these mistakes are common for all of us. These biases are unconscious, so we don’t know they are influencing us and how. But that doesn’t mean they can’t be destructive. We are all subject to them and may end up making costly mistakes in our own lives.

Several years ago JC Penney almost went bankrupt (and still might) because of some bold decisions made by then-CEO Ron Johnson. Mr. Johnson was a very successful executive at Apple, who moved to JC Penney to transform it into a successful company. The representativeness bias loomed large in the case of Johnson’s decisions. He believed his past success at Apple was representative of his future success, and he assumed the JC Penney consumer (who lived for weekly sales) was representative of the Apple consumer (who never get a sale and often pay a premium). It’s often easy to see in hindsight; not so much when it happens in real time. Life and decision-making happen in real time.

Investor Application

A good part of life is learning and improving our decisions. Learning often comes through mistakes. We can either learn from others’ mistakes or our own. Often, it is a bit of both. But it is always better to learn from another’s mistakes so we benefit from the lesson without experiencing the pain.

How can we protect ourselves from unconscious biases that may influence our investment (and other financial) decisions? One of the best things to do is to create an “advisory board” for our important and financially material decisions. Such board should include individuals that know us, care about us, and are different than we are. We don’t want to stack our board with “yes” people. We should seek out those that will challenge us, play devil’s advocate, and make us think.

Surrounding ourselves with people just like us is emotionally and socially safe. But when it comes to important decisions, they may not provide the “check” we need for ourselves and our biases. A spouse, partner, trusted friend and/or professional advisor may be worthy options for your board. It may be uncomfortable to hear objecting opinions and get asked tough questions. But challenging our thinking and assumptions may prevent us from making unwise and costly decisions. Remember, successful investing isn’t about being comfortable; it’s about being profitable.

Related: Why Don’t We Tip at McDonald’s?