Fitbit (NYSE:FIT) continues to grow its business rapidly. In Q3, the company's revenue soared 168% from the year-ago quarter and even increased sequentially during what has historically been a slower seasonal quarter for the company. But can this growth continue as rapidly in 2016?
Fitbit's growth potential
While Fitbit hasn't reported results for all quarters in 2015 yet, the company did note in its third-quarter earnings release that it expects total revenue to be around $1.77 to $1.8 billion. This would represent about 140% growth compared to revenue in 2014.
But growing revenue at this rate in 2016 will likely be difficult. And here's the key reason why: Next year will represent the first full calendar year where the company is up against Apple's (NASDAQ:AAPL) smartwatch, Apple Watch, for the entire year. Furthermore, the company will inevitably be up against a growing number of competitors as the connected health device market continues to be flooded with new entrants.
Fitbit management often refers to its market share data in terms of connected health devices with a GPS. This is somewhat fair, as Fitbit's health-centric devices skimp on Apple Watch-like interactive- and communication-rich features, instead narrowly focus on fitness. By doing this, Fitbit can produce these products at lower costs than feature-rich smartwatches, selling them at lower prices.
But the problem with tracking sales this way is that doing so ignores the elephant in the room: growing sales of smartwatches. Sure, some of Fitbit's products have very little in common with smartwatches. But a close look at its revenue mix reveals that its highest-priced items, which also are its products that most closely resemble the smartwatch market, make up the majority of the company's revenue.
"Our third-quarter revenue growth continues to be driven by our three newest products, Charge, Charge HR, and Surge, which collectively accounted for approximately 79% of our revenue, a slight increase from Q2," said Fitbit CFO William Zerella during the company's third-quarter earnings call.
Fitbit's Charge, the cheapest of these three products, costs $129. Its Surge, which is the company's most expensive product, sells for $249 -- fairly close to the Apple Watch starting price of $349.
With Fitbit's highest-priced products with the most features representing the majority of its revenue, the connected health device maker is likely to continue focusing on its products that overlap the most with smartwatch devices. This could spell headwinds for Fitbit as tech giants like Apple ramp up sales and marketing for their own smartwatches.
No wonder the company said in its third-quarter earnings call that it will be "investing more heavily in marketing" going forward. Fitbit is undoubtedly well aware of an intensifying competitive environment and increasing overlap between basic fitness smart bands and the nascent yet well-capitalized smartwatch category.
Investors are already seeing evidence of Fitbit's growing marketing budget -- and it's significant. During the company's third quarter, its operating expenses grew faster than revenue, up 206% from the year-ago quarter and 8% sequentially. What was the biggest driver for the huge year-on-year increase in operating expenses? Marketing, management said.
Evidence of management's expectations for headwinds sourced from increasing competition also seems to be surfacing in the company's research and development spending. The company's R&D head count soared in Q3, increasing from 173 in the year-ago quarter to 461. In its third-quarter earnings call, management cited hardware as "an important piece of the puzzle" in its growing R&D spend.
Going forward, investors shouldn't expect the company to continue growing as rapidly as it has in the past. In addition, investors should tune into the fourth quarter, as it will be the first time the company will provide useful insight into its expectations for 2016.
Daniel Sparks owns shares of Apple. The Motley Fool owns shares of and recommends Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.