Saying that a company with an agreement to be acquired for $2.1 billion was killed may sound like an exaggeration. Many start-ups aim to one day be “killed” in such fashion. However, Google’s decision to acquire Fitbit amounts to a mercy kill, putting an official end to Fitbit’s implosion at the hands of Apple Watch. In just three years, the Apple Watch turned Fitbit from a household name as the wearables industry leader into a company that will eventually be viewed as an asterisk when the wearables story is retold to future generations.

The Offer

When news first broke that Google LLC had offered to acquire Fitbit for $2.1 billion, or $7.35 per share, many observers noted how low the offer price was compared to Fitbit’s earlier valuations. This was a company that had its initial public offering at a $4.1 billion valuation and had seen its stock price peak at a $13 billion valuation ($51.90 per share).

My initial reaction was that Google was being extremely generous with its offer. On an enterprise value basis, which excludes $565 million of cash and cash equivalents on Fitbit’s balance sheet, Google is valuing Fitbit at $1.5 billion. For a hardware company with $1.5 billion of annual revenue and declining ASP and margins, questionable intellectual property, a dying ecosystem, and a non-existent product strategy, Google looks to be overpaying for Fitbit.

Industry observers speculate that Google’s offer price reflects the company seeing something in Fitbit that the marketplace missed. Instead, Google’s generous offer price has the makings of being a goodwill gesture aimed at Fitbit employees who have wealth tied to Fitbit stock. The $7.35 offer price represents close to a three-year high in Fitbit’s stock price. Holding Fitbit’s feet to the fire in terms of valuation wouldn't have helped Google retain Fitbit employees for beefing up its fledging hardware team.

On the flip side, Fitbit co-founder and CEO James Park and the board deserve a round of applause for securing such a generous offer from Google. The acquisition can be viewed as Google offering Fitbit a dignified and gracious death and Fitbit’s board as correct to take the opportunity.

Fitbit’s Story

There are two chapters to Fitbit’s life as an independent company. From 2013 to 2016, Fitbit leveraged low-cost, relatively rudimentary fitness tracker bracelets worn on the wrist to consolidate what had been a fragmented market for quantifying one’s physical movement. Fitbit even managed to move into the realm of coolness. Wearing a Fitbit in public contained positive connotations as the user was viewed as being on the forefront of technology. The smartphone revolution also played a role in Fitbit’s rise as people became comfortable giving a new crop of mobile devices an increasing number of roles to handle.

During the early years, Park successfully navigated Fitbit through a tumultuous period that included the company recalling the Fitbit Force for causing skin rashes and burns on nearly 10,000 people. Park also competed effectively against other early wearables pioneers. An ugly battle with the well-funded Jawbone regarding intellectual property theft ended in a settlement. Fitbit became a household name for health and fitness tracking.

Everything changed in 2016. Fitbit’s unit sales, as shown in Exhibit 1, peaked. On the surface, the subsequent decline in unit sales may not have looked too bad considering that demand stabilized around 15M units per year. However, for a hardware company dependent on rising unit sales, the development was alarming. Once again, Fitbit management did the right thing and quickly cut expenses at the first sign of demand weakness. The belief was that Fitbit could manage its way out of the sales slump.

Exhibit 1: Fitbit Unit Sales (Annual)

What management did not realize at the time was that Fitbit was beginning to feel the consequences of one giant mistake that Park had made years earlier. Park did not foresee the fundamental change that would take place on the wrist in the form of dedicated fitness trackers turning into full-fledged computers. Smartwatches aren’t just gloried fitness trackers. Instead, smartwatches are alternatives to smartphones and tablets.

After dragging his feet for far too long, Park knew that the only way forward for Fitbit would be to come out with a smartwatch. With the $300 Ionic, Fitbit launched its first smartwatch in 2017. The device flopped. Fitbit quickly pivoted to a lower-cost smartwatch with the $200 Versa. Once Fitbit had established channel inventory and satisfied pent-up demand for the Versa in its existing installed base, demand evaporated. Despite an even lower price, the Versa has failed to catch in the marketplace.

Why Sell?

In early 2019, Fitbit management began waving the white flag when it decided to pivot yet again, this time into services. In an effort to grab more users who could be monetized via paid services, Fitbit management began to cut into hardware pricing and margins. With the all-important 2019 holiday shopping season quickly approaching, Fitbit’s situation looked dire. Enter Google last week to officially put Fitbit out of its misery.

The only alternative for Fitbit, which was far from unproven, would be for the company to become a much smaller company, essentially a shell of its former self, in order to sell a certain number of dedicated fitness trackers each year to a declining installed base. Even if successful, Fitbit would have looked and acted like nothing that the world had come to know Fitbit as - a leader in the wearables category. Fitbit would instead become something of a zombie company.

How did Fitbit go from being considered the wearables leader to viewing a $2.1B acquisition as its best hope for shareholders to recoup any value? What led Fitbit to run out of options as an independent company?

Two words: Apple Watch.

Redefining the Industry

Apple didn’t just steal customers away from Fitbit. In such a scenario, Fitbit may actually have had a chance to survive as the company could have had a means to respond competitively. Apple ended up doing something that ultimately proved far worse for Fitbit. The Apple Watch altered the fundamentals underpinning the wrist wearables industry. This left Fitbit unable to remain relevant in a rapidly-changing marketplace.

Apple placed a bet that wrist real estate was being undervalued. The Swiss had dropped the ball and were primarily selling the wrist as a place for intangibles with high-end mechanical watches. Instead of following Fitbit and selling a $99 dedicated fitness tracker, Apple looked at the wrist as being a great place for additional utility beyond just telling time or tracking one’s fitness and health. Apple turned health and fitness tracking from a business into a feature. The Apple Watch redefined utility on the wrist.

This change led to consumers wanting more from wrist wearables. Apple Watch established a stronghold at the premium end of the market. Taking a page from its product strategy playbook, Apple then methodically began to lower entry-level Apple Watch pricing, which had the impact of removing oxygen from increasingly lower price segments. Fitbit was squeezed as the company had no viable way to compete directly with Apple Watch. Fitbit’s existing business wasn’t profitable enough for management to ramp up R&D in an effort to go up against Apple. Fitbit had generated just $200M of free cash flow over the past five years. Apple spends that much on R&D in a few days. Meanwhile, competition remained intense at the low-end of the market, which only added pressure to Fitbit’s existing business of selling low-cost dedicated fitness trackers.

Exhibit 2 highlights the number of active Fitbit users compared to the Apple Watch installed base (the number of people wearing an Apple Watch). The Apple Watch figures are my estimates. The exhibit ends up being the most damning evidence of Fitbit’s demise. Fitbit’s installed base lost all momentum just as Apple Watch began to take off. Unit sales trends continue to hide this deterioration in Fitbit’s installed base fundamentals. While Fitbit claims to have 28 million active users, that total isn’t enough to sustain a thriving ecosystem. In addition, there are valid reasons to question the loyalty and engagement found with those users.

A good argument can be made that Fitbit died a while ago, and the company is merely running on fumes from the dedicated fitness tracker glory days. With Fitbit, Google is acquiring a dying wearables platform.

Exhibit 2: Number of Active Users (Fitbit versus Apple Watch)

Number of Active Users (Fitbit vs. Apple Watch) - Above Avalon

Fitbit and Google

There is no rationale argument in support of Google buying Fitbit. Both companies lack a workable strategy in wearables. Fitbit doesn’t bring anything to the table for Google. Buying a fitness and health tracker going off of fumes is not a legitimate way to find success in wearables. Not only did Fitbit lack a sustainable product strategy going forward, but it’s fair to assume that Fitbit products will become even less attractive following a Google acquisition.

When a services company with data-capturing tools buys a dying hardware ecosystem built on tools that weren’t just data-capturing tools in disguise, an exodus of users is likely. Judging by how Fitbit decided to include the following paragraph in the press release announcing the acquisition, both companies are acknowledging the exodus risk:

“Consumer trust is paramount to Fitbit. Strong privacy and security guidelines have been part of Fitbit’s DNA since day one, and this will not change. Fitbit will continue to put users in control of their data and will remain transparent about the data it collects and why. The company never sells personal information, and Fitbit health and wellness data will not be used for Google ads.”

That paragraph won’t provide any comfort to Fitbit users concerned about their privacy in a post-Google acquisition. However, that didn’t matter to Fitbit’s board when accepting Google’s offer as their concern was found with Fitbit shareholders, not Fitbit users.

Success in Wearables

Many industry analysts, possibly in an effort to appease Google’s ego, have been going around talking up Fitbit as having a treasure trove of data for Google. The narrative concludes with Google somehow turning this data into an ingredient for success in wearables. This line of thinking makes no sense and is nothing more than wishful thinking.

Google’s problem in wearables isn’t due to a lack of data. In addition, Google’s lack of silicon expertise and dependency on Qualcomm aren’t fatal issues either. Ultimately, Google’s problem in wearables is that it isn’t a design company. At Google, designers are not given control over the user experience. Even if Google ramps up investment and hiring so that it is able to one day ship custom silicon that is competitive with Apple, the company would still need to come up with wearables that people want to be seen wearing. These products need to be born from a design culture in which the way people use technology is given more importance than just pushing technology forward.

Instead of acquiring Fitbit to find success in wearables, Google should work on changing its internal culture to empower designers at the expense of engineering. However, that change isn’t likely to materialize as the people who would be tasked with making such a decision would themselves hold less power and importance as a result of the change.

Fitbit will serve as a case study for what happens to a company underestimating Apple’s ability to redefine not just a product category, but an entire industry. Apple’s culture allows it to succeed in wearables. The company has spent decades learning to make technology more personal, and those lessons are being used to establish the most formidable wearables platform in existence. Apple Watch redefined what it meant to put utility on the wrist, and Fitbit simply wasn’t built to succeed in such a world.

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