This is actually a fantastic mechanism to motivate players to get and stay in shape. The key is to quantify fitness, and allow the players to gauge both their own fitness metrics and to compare to the other players (that is, post the results for all to see). Anson Dorrance, the UNC women's soccer coach, uses similar quantified fitness testing and allows the players to take the testing as frequently as they desire (self-motivated). With Dorrance I believe the motivators are positive and negative - players can earn playing time, but if they don't meet minimal standards they will not play. The results have been pretty good for his teams (20 national championships). This is the first I've heard of the Duke WBB program using this approach. I don't know the details, but ideally it is somehow individualized.
Of course skills, size, etc still play the major factor in playing time decisions. Otherwise, you'd have 5 walk-on starters from the cross-country team (and a freshman PG with 10%+ body fat would not see the floor).