ClassPass sacrifices 10% of customers in pursuit of healthier margins

ClassPass, the subscription service for fitness classes, became a household name because of one simple innovation.

The business model. Combining the breadth of a marketplace with a subscription pricing structure sparked a handful of similar startup launches (like Vive, which does the same thing with hair blowouts). But more importantly, it was the turning point for the company, putting it on course toward a $60 million annual revenue run rate for 2015.

But this year, the company hiked its prices, moving customers from a $100 monthly payment to a $180 monthly payment, at its highest, marking the first wave of doubt over this new-found business model.

ClassPass told TechCrunch exclusively that the company lost 10 percent of its user base following the price hike. That’s a steep cost, but it was also the price that had to be paid to get ClassPass back to profitability. For the month of September, ClassPass is now making approximately 20 percent gross margins.

But let’s start at the beginning.

Since 2014, ClassPass has been offering unlimited access to fitness classes across hundreds of local boutiques and studios for a flat $100 monthly price. But in April 2016, the company announced it would be hiking its pricing structure to $180/month for unlimited classes. Users could also purchase a ten-pack plan for $120/month and a five-pack plan for $65/month.

Not unsurprisingly, ClassPass loyalists weren’t exactly pleased with the new deal. The original premise of ClassPass was to give people unlimited access to a variety of fitness classes. But if users bought into the promise — that they could work out as much as they want, whenever they want, wherever they want — ClassPass simply wouldn’t be able to maintain that $100 unlimited price point.

See, ClassPass only pays its boutique partners for classes attended, and at a relatively steep discount (usually more than 50 percent). Since ClassPass users have different usage patterns — some may only go to a handful of classes while others might hit a class every day — a flat monthly rate ultimately meant that low-usage users were paying a premium to subsidize high-usage customers, who may individually be costing ClassPass money.

While that’s unfair to the low-usage users, it’s also just bad business. Because ClassPass reduces the friction of going to a workout class, the product itself catalyzes a natural progression towards working out more frequently.

“As the service got bigger under the unlimited tier, more deal-oriented users and fitness-oriented people alike were hearing about the service and joining,” Fritz Lanman, executive chairman of the ClassPass board, told me.

Close to eighty percent of ClassPass users are new to boutique fitness, based simply on how the product works. It only follows, then, that low-usage customers would likely begin working out more and more frequently the longer they stay with the platform.

If ClassPass achieves its goal of turning everyone into a workout fiend, the company’s $100 flat monthly rate effectively cuts off its own legs to do so.

Just before the summer of 2015, ClassPass made its first change. In various markets, the company began testing a $125 unlimited tier instead of $99. Around this time, having virtually achieved the vision of giving everyone access to unlimited fitness classes had started to turn ugly. ClassPass was seeing dangerously low monthly profit margins, and some months, going entirely negative.

Lanman told me that in December of 2015, six months after the initial price bump, ClassPass was operating at an 8 percent gross profit margin.

And while the unlimited price bump (from $100 to $125) got ClassPass back to profitability, it didn’t solve the real problem: some users were still subsidizing others.

“In a marketplace business like ClassPass, you’re looking for a take rate between 10 percent and 20 percent,” said Lanman. “And in a world where you have variable costs and different usage patterns, you have to price and create packages that serve each of your customers better individually. Customers benefit from revenue growth.”

And so, the company grew its revenue on a per-user basis with the introduction of a far more expensive unlimited plan, supplemented by Base (five classes) and Core (10 classes) packages. Today, the company is seeing around 20 percent margins, which are more evenly distributed between all users, from the three-class-per-month user to the class-per-day user.

But at what cost?

By ensuring its own healthy margin on each, individual customer, ClassPass may have taken some incentive out of the equation.

At $100/month, users were effectively rewarded for working out more. The more classes they took, the less they paid per class. Not only were they getting healthier, but they were saving money while doing so.

The new pricing structure eliminates that incentive. That’s not to say that ClassPass users aren’t getting a good deal. After all, these folks are paying for more than the classes themselves. The technology platform allows for more flexibility, better recommendations, and less friction than any alternative service or individual gym might offer.

And even without the incentive to reduce the class-by-class rate by going to more classes, ClassPass users can now rest assured that, whatever their usage, they are getting a fair deal.

A twenty percent profit margin for a marketplace may seem a bit steep, but it’s not outlandish. Airbnb, arguably one of the strongest marketplaces out there, takes a 3 percent commission on each booking, plus fees from the host between 6 percent and 12 percent, according to the WSJ.

But unlike Airbnb, ClassPass’s subscription pricing structure offers a level of protection against things like seasonality. In fact, ClassPass could make more than a 20 percent margin in the winter, when users may not go to the gym as much.

And when summer rolls around, and everyone decides to go to yoga once a day, ClassPass can rest easy knowing that it’ll still generate revenue off of each of its users individually, without being susceptible to a spike in usage.

As it stands now, ClassPass is seeing around 1 million reservations a month, with five percent month over month user growth. With the hard part over — watching one in every ten subscribers ditch the platform — and prices stabilized at a sustainable structure, the company can now start to think about how to move forward.

The original ClassPass (then called Classtivity) was so much more than a fitness boutique marketplace. The original vision included any type of class or activity that would help you become a better person, from dance to guitar to gardening.

With the ship back on course, I wouldn’t be surprised to see ClassPass venture into new territories. The most natural next vertical will likely be regular gym usage (as opposed to boutique fitness), where users could hit up local gyms for some treadmill time or weight-lifting. From there, we could see arts and culture subscriptions for events like the ballet or the theater, or subscriptions to pop-up restaurants.

But without healthy margins, that future could never become a reality.

“Ten percent is a big number, and it was a tough moment when we saw them leave, but after seeing how the business is going since the price change, we know it was the right decision,” said Payal Kadakia, ClassPass CEO. “It’s the only way to continue to create and move towards our bigger vision.”