Fitbit's Moat Has Proven Defensible Through The First Mover Advantage

Summary

• Fitbit may very well be the next GoPro without that next great product hit.
• First Mover Advantage done right is critical for creating a moat around a business model.
• Licensing is the new IP of the 21st century.

Fellow Seeking Alpha contributor Mark Hibben is right; Fitbit (NYSE:NYSE:FIT) is the next Go Pro (NASDAQ:GPRO). He outlines a strong case when he points to the lack of intellectual property that is needed to diversify Fitbit's product portfolio. But investors and readers should understand that intellectual property is not the backbone of creating a healthy and "strong like bull" economic moat around a business. However, it should be understood that Fitbit (FIT) is for all intents and purposes a one-trick-pony, hardware company that has developed a non-essential consumer good and they have marketed the heck out their products to the point of selling millions around the globe. Additionally, without a viable, defensible protective moat around the business model in the way of IP, they have become the dominant brand in the wearables category. So what is that worth? Today that is worth $13.60 a share; a far cry from the $17+ just a few days ago or the $50 price during the IPO period. But the depreciative value from then to now has very little if anything to do with having a moat around the business. Unfortunately, most investors, not some but most, simply do not think in those terms. Most investors think in terms of numbers and those numbers that Fitbit guided to for the 2nd Quarter of 2016 simply disappointed investors. But if you want to speak about intellectual property and a protective moat around the Fitbit business, let's do so.

The first mover advantage, when performed right, is the greatest protective moat around a business. Sure it leaves the door open for long-term issues if innovation doesn't find itself to support the first mover advantage, but this is usually the greatest moat around a business model. There are dozens of examples in the marketplace that demonstrate the first mover advantage serving as a protective moat around any particular business. Before we discuss a couple of examples, readers and investors should take note that without a viable intellectual property moat as described in "Fitbit Is The Next GoPro," Fitbit garnered greater than 85% of total wearables sales during the Q1 2016 period as reported by NPD Group. I'd say that is validation enough, but even so. In addition to that powerful statistic, certain retailers of scale will be increasing their shelf/slotting space by up to 50% of the wearables category for Fitbit products. Intellectual property or none, these two variables display Fitbit's overwhelming first mover advantage moat.

Keurig Green Mountain is a good example of a tiny company with a unique concept for serving coffee in the home. Keurig had the first mover advantage in North America. When Kraft Foods (KRFT) and Braun came into the space with Tassimo it didn't hurt sales for Keurig one bit. And then came Phillips Senseo, which found itself out of the marketplace in just about 2 years. Bottom line is that a tiny company called Keurig Green Mountain, in 2003-2005, went up against behemoths of industry in Phillips, Kraft and Braun and won that "battle" rather easily.

Amazon.com (NASDAQ:AMZN) can demonstrate another good example of how valuable the first mover advantage is. There really isn't anything proprietary about the Amazon.com marketplace and yet with hundreds of new competitors over the last decade, Amazon is doing pretty well. Netflix (NASDAQ:NFLX) anybody?

Moreover, what about the beleaguered SodaStream (NASDAQ:SODA) in the hardware space? Cuisinart announced their introduction into the home carbonation category in 2012, but found themselves out of the category in less than 12 months. Unfortunately, Keurig tried the same thing in 2015 with the Keurig Kold machine and that turned out to be one of the biggest mistakes in the company's history as they spent over $1bn to enter a category with inferior technology and an expensive widget. Little ole SodaStream was the first mover and the brand of choice by consumers around the world. Even with some of the largest appliance brands entering its category, SodaStream remained the brand of choice garnering 95% of home carbonation system sales in 2015. Besides being a first mover in the home carbonation category, the category itself was so new and unique to consumers that even these consumers didn't quite understand the category as a whole. What is an impediment to the SodaStream business also served as a barricade to the category for others.

The best example of how powerful the first mover advantage is, when performed right, Apple coming into the wearables space with an inferior product. Sales of the Apple Watch have been declining post the launch period and are identified in Apple's recent quarterly filing showing a 50% sequential decline in the "Other" sales category. Other is the category for which Apple designates Apple TV, iTunes, iPod and the Apple Watch. The worst part of Apple's CEO explanation for the decline in Apple Watch sales QOQ was that Tim Cook said it was a seasonal issue. Let me explain something about distribution and seasonality with respect to the Apple Watch. Apple has over 65,000 points of retail sale and the Apple Watch is in less than 15,000 points of retail sale. With all due respect to Tim Cook, you lowered the price of the Apple Watch, the Watch has the highest rate of return for any Apple product on the market and you have yet to state how many units you have actually sold even though "Other" paints a clear picture. And by the way, Tim Cook also said that the Apple Watch is the biggest contributor to the Other sales category so when the sales category goes down it goes down in large part due to the Watch. With 65,000 points of retail sale available to Apple globally, Apple is finding it difficult to ask retailers to buy into the Watch inventory given the sales trends for the product. Looks like Fitbit's protective moat and dumbed down version of a smartwatch didn't need the Apple "technology might" of IP for any significance. I use quotes for technology might because let's face it; if Apple isn't licensing the technology from an OEM, they are acquiring the technology's owner. And that brings us to another key perspective.

While the article "Fitbit Is The Next GoPro" positions Fitibit's assets or balance sheet as not being able to satisfy a need for innovation, licensing has become the key to successful technology relationships in the 21st century. While it would be ideal to create a company's stand alone, defensible IP, with technology advancing through creation so quickly nowadays, it is far easier to license desirable technology with exclusivity. Apple, Samsung, Whirlpool (NYSE:WHR) General Electric (NYSE:GE) John Deere (NYSE:DE) and hundreds upon hundreds of companies around the globe advance and defend their business models with licensed technologies that carry exclusivity agreements. Generally, licensing agreements are a less expensive alternative to self-driven and created intellectual properties. The exclusivity aspect of the licensed technology agreement locks-out competition for a stated period of time and sometimes for stated regions of use. Capital Ladder Advisory Group places licensors with licensees all of the time and we have witnessed how effective such a strategy works for protecting a business with licensed technology in many categories and over the years.

In all the aforementioned examples technology and IP be…darned, as they played little role in the relevance of dominating a category and sales for their respective categories. But even so, that first mover advantage can only take a company or product to a point of market saturation and once that time comes you better have the next product to take you to the next level. GoPro didn't have that next product.

That is really what Mark Hibben was pointing to when speaking about Fitbit's lack of a protective business moat. Contextually, his article could be elevated by stating more specifically that Fitbit will end up like GoPro because both companies are one-trick-pony, hardware companies and when Fitbit saturates its markets, sales will decline just like GoPro's have. And for that there is no opinion in the matter, it is definitive and proven throughout history. And as far as profits are concerned, when sales decline so do profits as gross margins contract. It simply doesn't happen any other way. But with that being said Fitbit is somewhat in a category that can lend itself to clinical/medical application of its wearable devices.

Let me be clearer on the matter. In no way do I believe today that Fitbit has the ability to transcend Fitbit from the consumer market to the medical marketplace. For all of Fitbit's clinical study participations and all of the hyped life saving articles; this is all publicity. This is branding and marketing on the part of Fitbit and kudos to them for their participation. But physicians can't prescribe a Fitbit to their patients as they have no Class 2 status, they are not FDA cleared and they are not medical grade devices. If you are buying into the hype of medical applications given this robust attention Fitbit is offering toward that space, you are likely going to be very, very disappointed. The medical device market for remote patient care and mobile cardiac telemetry (MCT) is one of the most protected and difficult industries to participate in and break through. Secondly, using the Fitbit model of technology and applications they never will be able to get into that space. Fitbit has to do something else to get into the field of medical applications. Not for nothing, but so does Apple if they want to have a more desirable wearable product.

Wearables/fitness trackers are non-essential products and thus carry a very high attrition rate with a very low usage rate. The biggest problem with fitness trackers is that they are all passive devices. It's funny that the Fitbit product that "saved" the man's life in the USA Today article, his symptoms occurred three hours prior to him entering a hospital. Hence, the Fitbit fitness tracker did a great job of recording, but for the love of gosh man, can we get a tracker with real time feedback! What good is tracking the cardiac event if it can't tell me when I'm in actual distress? What if I didn't get to the hospital in time?

All fitness trackers are passive instruments and they force users to perform additional tasks to achieve the data. That is not a device that will ever work for clinical applications. It would behoove readers and investors to look up mobile cardiac telemetry. This is where Fitbit needs to move. That doesn't mean they dismiss the consumer market, as there is a medical grade solution to be found for the consumer market as well, but rather Fitbit needs to participate in both to protect its business model long-term. And that is at the core of the investment thesis for Fitbit. Today, Fitbit is a simple, one-trick-pony, hardware company with a rather flawed product for practical purposes. As that may sound like an opinion, it is validated in certain of the company's reported metrics. When Fitbit saturates its markets over the next several quarters, sales will plunge. The sell-through results already indicate this and Fitbit's revenue growth rate deceleration further identifies issues with sell-through. As it pertains to GoPro, this company saturated its market much faster than Fitbit for a variety of reasons, but most importantly because the total addressable market for action cameras is significantly small when compared to that of wearables. On price point alone GoPro was a losing proposition for consumers and investors. If you want to know for sure when Fitbit is on the cusp of saturation and sales declining, just keep an eye out for a "Today's Special Value" deal on HSN or QVC. All of these small hardware companies play the same game in the same way.

Before we conclude, you might recall in a recent article that I discussed that Apple is coming downstream with wearables, if not in form and function then definitely with price.

The reality of the situation facing the Apple Watch is that it is forced to move down market in price. Fitbit is not moving upmarket either as offered by Mr. Lehar as the Blaze is actually priced lower than the former "Surge" Fitbit product. The consumer recognizes the duplicate technology of the smartphone offered in this Apple Watch and the sell-through results highlight consumer purchase intent. Suggesting that Fitbit will have difficulty competing against Apple in the smartwatch segment when Fitbit has already displaced the Apple Watch from its top sales position so quickly begs for readers/investors to consider what is more pertinent.

With this in mind, the potential to compete more rationally with Fitbit in the wearables space may yet be at-hand for the behemoth of consumer goods. You see, Apple does have a growing relationship in the fitness tracker space with a small company that has pretty unique fitness tracker applications with more direct feedback. Moov is the name of the company and guess who is the only retailer selling the "Moov Now" fitness tracker products; that's right, Apple in their Apple stores. The Company has sent me their latest iteration of fitness trackers for demonstration purposes and I will be testing them over the next 30-day period for efficacy.

In conclusion, I'm long Fitbit for the trading opportunity. I won't paint some pretty picture for investors regardless of my position in FIT or any trading vehicle of choice. Others can do that job for what may be believed to be required reading. What I offer readers and investors is a more complete scope of pros and cons and how to weigh those pros and cons in terms of probability. I promote many variables in Fitbit analytics in advance for which nobody is yet to discuss. A perfect example of such relevance is my first articulations on total addressable market and attrition concerns. Only recently, and again the only individual putting forth the subject matter, did I begin discussing Fitbit's warranty reserves. Readers and investors will notice that for the first time, Fitbit discussed this issue with investors on the latest conference call. My next Fitbit dedicated article will highlight one of the best paths forward for Fitbit that will enable the company to transcend market applications for its products. Remember, licensors work with Capital Ladder Advisory Group to pair with licensees.

In order for Fitbit to find itself a greater opportunity for sales growth longevity, simple fitness trackers won't do the trick. Fitbit needs to find that next opportunity and they seemingly have the concept, but lack the technology and/or know how to date. As an investor, understand that if they develop or acquire that technology you, the investor, are paying for it on some level. That is what is being identified in the share price depreciation to some degree already and keep that in mind when the company is boasting about all of their engineers. "You are paying for it in the share price and through the disappointing Q2 2016 forecasted earnings per share". If investors perform a cost of acquisition model on Fitbit fitness trackers it is astonishing. And yet nobody is talking about this? I wonder why!

Disclosure: I am/we are long FIT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.