Is The ClassPass Model Sustainable?

Inside a sparse concrete studio crouch a man and woman, both outfitted in athletic attire, buttocks in the air, hands on black sandbags, preparing to push the heavy sacks across the length of a long foam mat. “Go! Go! Go!” a trainer yells, beckoning them to begin the workout. For $38, exercise masochists can spend an hour throwing weighted balls at a ceiling and haphazardly climbing over tall walls at Brooklyn’s Warrior Fitness Boot Camp studio. But for those who don’t want to plunk down that much cash for an army-drill inspired workout they’re not sure they can finish, there’s ClassPass—a three-year-old service that, for a monthly fee, connects fitness novices and workout junkies with a wide range of boutique exercise classes at a discounted rate.

Founded by Payal Kadakia, ClassPass has raised $84 million from investors like Google Ventures and Thrive Capital. With services in 36 cities around the world, it is one of the most prominent of the subscription plans that have emerged in the last several years. The allure of these new subscriptions is they automate would-be chores. You can now schedule a box full of goods to arrive on your doorstep monthly and eschew a drive to the store for basics like paper towels and face wash. The subscription model has also become a tool for organizing monthly activities like getting your hair styled or going to the gym, and has created a market around quickly scheduling the hours of your day.

But as ClassPass has expanded over the last two years (and even imagined branching into other kinds of activities like museums and movies), the company has substantially raised the cost of its popular pass, alarming some its rabid fan base and raising questions about its model. At the start, ClassPass’s New York City users paid $99 a month for unlimited fitness classes. Then, in 2015, it raised its price to $125 a month. This past summer, that number jumped to $190 a month for unlimited classes. The surge, designed to fatten margins, cost ClassPass 10% of its users, according to TechCrunch. An internal company document from January 2016 detailing ClassPass financials for all of 2015 was leaked to Fast Company and reveals that the company faced difficulty bringing in enough revenue to outpace the cost of paying class providers, like the dance studios and gyms that ClassPass partners with. While it seems the company has, at least for the time being, stemmed some of its operating costs, its difficulties have cast doubt over the ClassPass model as a viable—and repeatable—formula for long-term success.

How ClassPass Works

This business model is complicated to get right, in large part because a company has to identify a pricing structure that pleases both customers (who want it to be as low as possible) and service providers (who want as high a cut as possible), while cutting itself a portion of sales. ClassPass makes its money from memberships; the exercise studios it partners with make money from ClassPass, which pays those facilities a discounted rate for every ClassPass customer who signs up for a spin class or barre session.

In 2014, ClassPass offered unlimited classes for $99 per month—a great value for active customers who want the boutique fitness experience (a traditional single-gym or single-studio membership can cost anywhere from $10 to $300 a month in New York City). Frequent class-goers could significantly drive down their cost per class on otherwise expensive boutique classes by going to lots of classes. Spreading $99 across an entire month of daily classes equates to paying $3.30 for each individual class, if a power user takes a class every day. The opportunity to save money on workouts and the ability to book classes through ClassPass’s well-designed app lured a lot of customers onto the platform. But as time passed, it became increasingly clear that while this flat-fee subscription rate was great for onboarding users, it wasn’t good for ClassPass’s overall business.

Subscriptions have to be priced in such a way that they cover the costs of the service. Earlier this year, when ClassPass dramatically (and controversially!) increased its prices from $125 a month to $190, it also introduced two new tiers of pricing: five classes for $40-$75 and ten classes for $89-$125, depending on the location. Some regions still have access to its original $99 unlimited subscription, but in major cities like New York, Chicago, and Los Angeles, ClassPass had to hike up its prices. “For the majority of users, a 5-plan or a 10-plan is actually a cheaper proposition,” says ClassPass founder and CEO Payal Kadakia, reasoning that it’s cheaper than the $125 per month customers were paying before.

What separates successful subscription companies from flailing ones may be a matter of the kinds of products they’re pushing. Subscriptions like The Honest Company, which send “bundles” of its branded products to monthly subscribers, tend to do well, says Leavitt. What differentiates Birchbox from some of its box-subscription contemporaries is that Birchbox isn’t selling its own products via subscription. It’s using the subscription to introduce customers to a bevy of beauty samples, the way an old-fashioned beauty counter might, in the hopes that they’ll eventually buy full-size products later. This managed to accrue a subscriber base, but the subscription was not supposed to be the main source of revenue. It was primarily a way to get customers hooked on a product and eager to buy it regularly at full size on Birchbox’s website, rather than a mechanism for triggering a steady supply of revenue. This is where subscriptions get tricky. “It’s hard to carve out margins as a middleman, and we’ve seen that most of the subscription startups with the most momentum have been those that sell their own branded goods—like Dollar Shave Club, Harry’s, and Peloton,” says Levitt.

Hyper-Growth

ClassPass CEO Kadakia says the profit losses were all a part of a big plan to grow the business. In 2015, as an answer to rapidly spawning competitors, ClassPass decided to go for hyper-growth. In the U.S. ClassPass was up against Fitmob and FitReserve; in Australia it was ClassHopper, Kfit, SweatPass, and Bodypass; in the U.K. it was Somuchmore. Kadakia remembers seeing one of these “copycat” websites for the first time and feeling the need to scale ClassPass quickly in order to lay claim to the subscription-fitness idea. “We’re going to go fast and we’re going to go hard,” she recalls thinking, sitting comfortably on a gray couch in one of ClassPass’s living-room-esque conference rooms at its New York headquarters. “This is our product to protect.”

Last year, the company pushed its subscription platform out to 36 markets, including cities in Australia and the U.K. In April 2015, it also acquired Fitmob. The ramp-up helped lead ClassPass to a $17 million loss for the year, though as of January the company still had $25 million sitting in its coffers from previous funding.

Rapid expansion also took a toll on the company’s workers, and Kadakia reached her personal limit trying to run a 200-person company. She says at a certain point last year, she realized she needed help. So, in December 2015, then-executive chairman Lanman became ClassPass’s co-operator. An internal source says Lanman took over day-to-day operations despite running two other companies, Doppler Labs and DWNLD.

“The skill that she has, that very very few entrepreneurs have shown, is an ability to create something new that appeals to the zeitgeist,” says Lanman. “It’s hard to do this well, so we wanted to focus more of her energy on that.” What Kadakia had finally hacked was getting people to sign up and go to fitness classes, a hurdle she couldn’t clear with her two earlier products, Classtivity and Passport. But getting people to exercise came at a cost, and the company needed to make adjustments accordingly.

With Kadakia focused on creative endeavors this year, Lanman fleshed out ClassPass’s executive ranks. He worked closely with the company’s interim COO, Steve Wietrecki, who was with the company throughout 2015. Rather than hire a full-time COO, Lanman brought on a new CTO, former Amazon customer experience exec Sam Hall, and a new CMO, Joanna Lord.

Reevaluating Costs

Simultaneously, the company began tightening its belt. Since April, ClassPass appears to have had two rounds of layoffs, according to inside sources. Data from LinkedIn reveals a string of 15 to 30 people left the company between April and June. The staff cuts came as the company was taking other measures to get lean. It purged many of its internal perks, including free memberships and catered lunches for employees, according to former staff. Around the same time, ClassPass announced its price increase.

“It’s hard to create a flat rate,” says Matt Dibb, founder of ChildPass, an Australian ClassPass clone focused on activities for kids. While he watched ClassPass’s early success, Dibb didn’t do much investigation before embarking on a similar product. He says the most difficult part of creating a children’s activity pass was developing a consumer acquisition strategy: making the subscription affordable enough to entice consumers, while also charging enough to cover the cost of the actual class. It was so hard to make work that Dibb pivoted his business and now sells a scheduling and payment interface for children’s class providers.

For ClassPass, on the other hand, the flat-rate unlimited subscription was great for nabbing new customers quickly. Like an all-you-can-eat buffet, the value proposition is obvious. “The one-size-fits-all model worked really well in that it made the sale simple,” says Lanman. But since the $99 rate also attracted exercise fanatics (those who were taking so many classes it was reducing their individual costs per class to less than $10),the price change may have been aimed at churning some of these power users out.

The initial price move, from $99 to $125 in July of 2015, did lead to a loss of subscribers, but its hard to tell how many. Revenue alone won’t indicate how many people left, because pricing is not uniform across markets. While all of ClassPass’s cities experienced a price increase, some saw smaller increases, from $79 a month to $99 a month as opposed to $99 to $125. (Creating another layer of complexity in understanding ClassPass’s metrics is that existing subscribers didn’t have to start paying the new subscription price until two months after the announcement.) However, an examination of ClassPass’s financials shows that revenue growth rate sunk from 11.4% in July to 2.67% in August. Growth stayed slow until November when it dipped to negative 2.4%.

The initial price raise wasn’t enough to offset ClassPass’s costs. It also wasn’t helping to bring on new customers. “We realized it wasn’t going to work,” says Kadakia. The unlimited pass, along with seasonality, new product launches, and other variables made determining both revenue and costs month to month an onerous process, she says.

For instance, a lot of people hit the gym harder in January, but workout binges and hiatuses are not the same for all customers. “No business is good when on the last day of the month you’re like, what was the usage for the month?” Kadakia explains. “There was such variability in terms of what our margin would be based upon, what the usage would be, and so what we wanted to do was stabilize that.”

This realization preceded the next price increase in April 2016, this time in multiple price tiers, which sought to make ClassPass’s month-to-month financials more predictable by capping the number of classes included in some of the offered plans. Kadakia and Lanman also wanted to figure out how to appeal to a crop of fresh users who weren’t already familiar with the cult of Pilates, spin, and Pure Barre. They thought a $40-$65 per month 5-class pass might pique users’ interest without intimidating them. “It’s just a more balanced business model and it did strengthen unit economics across all our different customer segments and demographics,” says Lanman. He says it also offered a better deal to those who were paying for unlimited classes and only going to class a few times every month.

But even after reestablishing the prices of its passes, ClassPass still has to contend with the cost of the classes themselves. For the majority of 2015, the cost of venues alone was still outpacing incoming revenue from subscriptions and missed class fees. In the last three months of the year, the company was able to grow revenue just above the amount it was paying out to fitness studios. But then, in January 2016, venue costs jutted upward, surpassing revenue.

Unpredictable Numbers

The ups and downs reveal a core issue with ClassPass: Its business is unpredictable. Kadakia and Lanman, who often finish each other’s sentences in conversation, say they can’t foresee how much people will use their pass, even with the data they’ve amassed. There’s a big difference in margins between a frequent user and an occasional one. While they know that every month class-goers will miss classes and have to pay a fee, they can’t really know in advance how many people will do that. The tiered pricing is meant to introduce more certainty to the company’s finances, by limiting a customer’s ability to drive down their own class cost. More robust data analytics may also take some of the guesswork out.

But ClassPass’s margins can still be pretty thin. For example, if someone is using their 10-pass to the fullest extent, they’re paying $12.50 per class. To turn a profit, ClassPass has to pay the studio less than $12.50 for that same class. It may be difficult to convince studios who charge upwards of $20 a class to let go of their inventory for less than 60% of the purchase price. Even though the service’s unlimited tier (now $190 per month) is significantly more expensive than it used to be, it’s still not enough to cover the the costs of a dedicated super-user. While plenty of customers may not use the pass that often, delivering ClassPass better returns, ClassPass subscribers tend to go to class more over time, not less, says Kadakia.

That’s why ClassPass may be phasing out unlimited altogether. If you try to sign up for ClassPass in major metropolitan areas like New York or Chicago, you won’t see the unlimited subscription plans, only the 5- and 10-pass options.

Other activity subscriptions are slowly backing away from unlimited passes, too. Vive, an app for scheduling salon-style hair washing and drying, launched with a $99 unlimited pass. Now, the app offers $69-, $159-, and $239-a-month memberships guaranteeing members a set number of blowouts. In the new system, the cost per appointment can’t be driven below $29. MoviePass, which originally allowed users to see one movie per day for $25-$40 per month, also switched from a cheap all-access pass to a tiered system. In every case, the new pricing model is set up to cover costs that the unlimited subscription model wasn’t supporting.

ClassPass says its experimenting with its homepage to see which plans perform best in attracting new customers; the company hasn’t decided whether it will ditch the unlimited tier or not. Even with unlimited gone, Lanman and Kadakia don’t seem convinced ClassPass’s current manifestation is necessarily tenable.

“We’re not feeling financial pressure,” says Lanman over the phone. “But we do obviously want to make sure that it’s sustainable and I don’t think we can commit to that because we don’t have enough data yet.” To his point, Business Insider reported that the company has a $150 million run-rate for 2016
as well as a 17% gross profit margin. Layman confirmed that gross profit margins are sitting around 20% month-over-month. ClassPass’s thicker profits margins are likely the fruits of its cost cutting and subscription price increases. But its fast growing revenue may be a short term success. Lanman acknowledged that even with the new tiers in place, if people use all of the classes allotted in their subscription, ClassPass doesn’t make a profit. The question will become, if people really do use the pass more over time, how will the company sustain itself? And if people continue to underutilize the pass, how will ClassPass be able to prove to those customers that its worth the expense?

Moving Forward

In the meantime, ClassPass is developing some new products that might further help its bottom line. For instance, Kadakia says the company is experimenting with using dynamic pricing to determine how much it should pay studios for the classes they can’t sell through regular channels. In the future, using the data it has accrued over the last three years, ClassPass might pay studios different rates for classes depending on time of day and the likelihood of those classes being filled. To build out customer offerings, ClassPass is starting to offer those who want more than three classes at a specific studio an opportunity to purchase more classes through its network.

ClassPass has had to build technology to help many of these fitness studios track class inventory, explains Kadakia, and the company is open to creating more products for fitness studios. It’s recently launched a product called “smart spot,” which is an algorithm studios can turn on to automatically release class spots to ClassPass based on historical data.

“I think we can do a better job, as Payal alluded to, helping them with better customer service, give them more CRM tools,” says Lanman. Embarking more deeply into services for its venues could be a wise move. ClassPass’s relationship with its studios hasn’t always been particularly solid. As Jenna Wortham’s 2015 story for the New York Times showed, studios see the service as a good marketing resource that draws in more customers, but one that inherently devalues their product. Some studios have watched students with monthly memberships defect to ClassPass because it offers a better deal. Why pay $175 each month for access to a single studio when you could pay $125 a month for access to a multitude of studios? Building more tools for studios, and doing away with unlimited plans, could certainly help to bolster ClassPass’s relationship with studios.

Currently, MindBody is the biggest player in a market that sells software to boutique fitness outlets for scheduling appointments online, managing staff, and offering a point-of-sale system. But there’s room to compete and ClassPass may be wise to do so. MindBody has already rolled out its own ClassPass-like app simply called “MindBody” (it was formerly named “Connect”). If ClassPass could develop business-management tools for fitness studios, then it might be able to profit enough to justify the expense of its subscription business.

That approach is similar to the one that Australia-based ChildPass pivoted to, and so far the company says it’s working for them. The company now offers an interface through which class providers can sell classes, but without subscriptions. It also provides those teachers and studios software with which to manage their businesses.

This isn’t as sexy as some of the more consumer-facing product ideas ClassPass has dreamt up. In April, Vanity Fair revealed a leaked pitch deck from ClassPass describing something called “LifePass.” The big vision appeared to be to build out ClassPass to include access to museums and other activities.

Neither Kadakia and Lanman would confirm the Life Pass idea, except to say ClassPass is continuing to explore other classes it can add to its roster. For example, Kadakia says she’s looking into a gym pass that would give users access to a variety of gyms. She’s also thinking about activities outside of fitness. Already the company has experimented with offering massage, Daybreaker parties (booze-free early morning raves), movies, and dance shows on its app, says Kadakia.

Meanwhile, Kadakia continues to beat the drum for expanding the subscription. “People use our app to book the daily hours of their life,” she says. “I think we’ve done that with the amazing space of fitness, and for us it’s about what else can we apply that to.” In line with that thinking, the company has rolled out a new home screen that will present users with activity suggestions based on activities they’ve chosen in the past, what people who have similar tastes like, and their present location.

Whatever direction it goes in next, it will be with an eye toward financial sustainability, Lanman says. “We’re going to get a lot more data about behavior change and that’s going to end up predicting what we do next.”

Both Kadakia and Lanman have a phrase they use to talk about growing the company, which involves “earning the right to work on the next thing.” To work on new products like the one Kadakia envisions, they say, they must prove the business is ready for it.

Correction: The name of MindBody’s app is MindBody. A previous version of this article referred to it under its former name, Connect.