It has been a tough ride for Peloton Interactive (PTON 2.85%), whose shares have cratered 95% over the last year and a half. The pandemic was definitely good to the fitness innovator, as stuck-at-home consumers turned to convenient options to work out at home. But a reopening economy caused demand to fall and net losses to soar. 

To help keep costs under control and improve the financial situation, management just announced that they will halt all in-house production of the company's exercise equipment and will instead rely solely on third-party manufacturers. This latest move has the potential to better position Peloton to be sustainably profitable sooner rather than later, something I'm sure investors desperately want. 

Getting back into shape 

In addition to suspending operations at Tonic Fitness Technology, a Taiwanese manufacturer that was acquired in Oct. 2019 for $48 million, and expanding its partnership agreement with Rexon Industrial, Peloton previously announced that it will sell the planned $400 million Ohio factory, called Peloton Output Park. Furthermore, this pivot calls into question what the company will do with its acquisition of Precor, which was purchased to boost manufacturing capabilities. 

It's obvious in hindsight that the previous CEO, John Foley, overinvested in the hopes that the pandemic surge in demand would continue well into the future. But with physical gyms getting back to full strength, as well as worries of a potential economic slowdown, Peloton is facing a difficult time right now. 

Unsurprisingly, Peloton was last profitable during the depths of the coronavirus pandemic. In 2020's second quarter, the business produced positive net income of $89.1 million with a margin of 14.7%. Over the past four quarters, however, Peloton has posted a cumulative net loss of $1.9 billion. For comparison's sake, the company's entire market capitalization is just $2.8 billion. 

It's strikingly clear that the current management team, led by new CEO Barry McCarthy, has a primary objective of getting the financials of the business in order. Consequently, shareholders shouldn't be surprised by a huge change in direction like this one. 

Owning your own factories and producing goods in-house benefits a company if it can reach mass scale, at which point the per-unit cost of merchandise is lowered and profitability can skyrocket. But this strategy also comes with drawbacks, mainly if a business isn't seeing as much demand as it had initially expected. If revenue doesn't meet or exceed what management had forecast, then the fixed costs of owning the manufacturing process will simply result in higher losses. We've seen this play out for Peloton. 

On the other hand, outsourcing manufacturing is exactly what Peloton needs at this point in time. McCarthy is aiming for financial flexibility with a more variable cost structure. This is critical right now because Peloton has been facing an environment where it has been extremely difficult, if not impossible, to forecast demand with any level of certainty. Outsourcing manufacturing means that the business will only pay for each piece of equipment that gets made, and not directly for owning the actual factory itself. 

Apple (AAPL 0.81%), for example, outsources the manufacturing of nearly all of its hardware products to other companies. And it has the most successful product of all time in the iPhone. Even with such massive demand, Apple has decided to focus on the design and software components as opposed to assembling the hardware, something Peloton wants to start doing now. 

I certainly applaud Barry McCarthy so far. He took over a troubled business that was facing a laundry list of issues, and he has taken major steps to right the ship. While the latest decision to cut all in-house manufacturing in favor of an outsourced model appears to be the correct move, what really matters is if Peloton can drive higher demand for its exercise equipment, which will increase subscribers. Hopefully, this raises the chances that the company can generate positive free cash flow starting in fiscal 2023. 

And this is what will ultimately move the stock price over the long term.