Fitbit IPO – the reference for the modern hardware startups

So it came. Fitbit filed for IPO (NYSE:FIT) on May 7th, 2015.

I have a feeling that 5 years from now people will be referring to this IPO over and over again when they talk about the hardware revolution that is actually already happening now and which we at the Hardware Club have been championing and supporting with actions for years.

Modern hardware startups are hitting IPO, starting with the brilliant Fitbit

As a startup of 7+ years old, backed by $66m of VC money over four rounds by prominent firms such as True Ventures, Foundry Group and Qualcomm VenturesFitbit has many of the characteristics that symbolize the modern hardware startups. The only major piece missing is the fact that it never went through the crowdfunding phase.

But then again, Kickstarter was launched in April 2009 and didn’t become a hardware hotbed until several years later. Fitbit on the other hand was already shipping its first Fitbit tracker in 2009. I believe if James Park and Eric N. Friedman had started Fitbit or any sort of hardware startup a couple of years later, they would definitely have enjoyed having Kickstarter/Indiegogo as a perfect launching pad.

Whatever the story, Fitbit’s IPO is bound to become that reference point for us to return to years later when this hardware revolution becomes widely recognized and accepted as a fact. It is therefore worth digging into its S-1 form at this moment.

Consider this a case study, but more importantly, take inspiration from Fitbit’s execution. Much like in the lean startup revolution, in this hardware revolution you have many non-traditional tools available for a startup to defend its business and achieve an exponential growth.


Exponential growth

The most eye catching part in Fitbit’s S-1 form is that as a hardware startup, which has traditionally been regarded as heavy (not lean enough) and slow-growth, it achieved beautifully exponential growth.

The importance of exponential growth is often overlooked by hardware entrepreneurs, who usually focus on solving certain problems or pain points and complain about the lack of vision (a.k.a., interest in them) of the VCs. The fact remains that while all problems are worth solving, only those that could lead to exponential growths (either in user counts, transactions or revenues) are VC-investible.

And Fitbit has achieved this beautifully, reaching $745m worth of revenue in 2014. One then naturally wonders how they drove the revenue growths, i.e. how much did they spend on sales and marketing.

Fitbit did not need to overspend in S&M even in early years

It turns out that even in the early years, Fitbit did not spend a lot on sales and marketing. Up until 2013 its sales & marketing accounted for less than 14% of the revenue. It’s reasonable to deduce that they relied heavily on word of mouth and the network effect of their user community in the early years.

Year 2014 was really the first year when they went with the traditional tools, such as a partnership with Tory Burch offering accessories for the Fitbit Flex in February.

The result is simply beautiful — for the full year they spent $112m on sales & marketing and significantly boosted its revenue from around $300m in to $753m in 2014 — note that I have adjusted the revenues for the Fitbit Force recall. This represents a 150% YoY growth that any lean startup would kill for when if it’s merely MAU, let alone real revenues!


And Fitbit is making money — tons of it!

Here comes probably the major divide between the modern hardware startups and their lean brothers that have dominated the startup headlines for more than a decade — Fitbit is already making money when it filed for IPO!

We’re talking about rock solid net income of $131m over a revenue of $745m in 2014. That’s an extremely healthy net margin of 17.7%!

Today big smartphone firms such as HTC and LG would kill for this net margins, no doubt!

And net income doesn’t actually tell the real operational story of a startup in high-growth phase as the company is still heavily investing and incurring growing depreciation up front. Usually we look at EBITDA as an indicator for the operating performance. And in this case, Fitbit achieved an eye-popping adjusted EBITDA of $191m in 2014. That’s 25.6% EBITDA margin!

And if you’re making a healthy net margin, for sure your gross margin — the one figure that most hardware naysayers trash about the most — is gonna be beautiful as well:

As you can see, the gross margin of Fitbit improved over the years and reached APPLEish 50% in 2014!

Note: If you just grab the S-1 financial revenue and gross profit numbers, you will have a lower GM (48%) in 2014 and a much lower GM (22%) in 2013. However, both years were impacted by the recall of Fitbit Force. To measure the real gross margin which is a reflectance of a hardware firm’s pricing power and cost management, the decrease in revenues and increase in COGS should be taken out. One will find that the adjusted GM in 2013 would be 47.1% while that of 2014 is 50%.

Now 50% is not just a random number for anyone in the hi-tech industry long enough. Before Steve Jobs revived Apple from its doldrum, it had been years where end device makers had lower gross margins than up-stream vendors such as fabless IC design houses.

For example, the measure stick for the later has historically been (and still is) 50% gross margin. Any significant dipping would drop the share prices of IC design houses significantly. On the other hand, large electronics makers such as Sony, Panasonic, HP and Compaq would be happy to have 20–30% gross margin.

Then Apple came along, proving to everyone that if an end device maker can create complete and overwhelmingly superior user experiences, it can make 50% gross margin as well.

Now Fitbit is letting us know that: you don’ t have to be Steve or Tim. You can be a startup and do the right things in design, engineering and marketing, and it will lead to a healthy gross margin for your business.


How about the paid services?

This is where the discussion gets interesting.

Fitbit has achieved a similar growth in its Paid Active Users, going from 558k (2012) to 2.57m (2013) and then to 6.7m in 2014. This is remarkable since any single user could own multiple devices:

The number of paid active users is based on subscription and device activity associated with each Fitbit user account and, accordingly, a user with multiple devices synced to his or her Fitbit account is counted as only one paid active user regardless of the number of devices that such user syncs to the account. (Source: Fitbit S-1 Form)

In any case, some would then argue that Fitbit’s superior gross margin was probably helped by its paid services, which enjoy much higher gross margin.

Well, yes and no.

Yes in the sense that the services, including all the social networking part, help retain the users and create stickiness. However, in its S-1 form Fitbit stated clearly:

We generate substantially all of our revenue from the sale of our connected health and fitness devices and accessories. We also generate a small portion of our revenue from our subscription-based premium services. (Source: Fitbit S-1 Form)

I think there’s no doubt that the hardwares the Fitbit has been selling enjoy a healthy gross margin at around 50%. Now imagine at some point Fitbit starts to effectively monetizes the paid service users 


Bottom line

The lesson for us from Fitbit is very clear: if you can create a wonderful product with great user experiences, driven by properly staged marketing effort, you can create an exponentially growing business even as a hardware startup.

In fact, you’ll do even better than your lean friends — you’ll be already making money for your shareholders when you hit the IPO!

Fitbit's $6B IPO by numbers

Signal and noise in the eyes of engineers and financiers