Sunday, March 4, 2007

An Assessment of the Gap

As promised last weekend, every weekend I will stray from my normal blog and provide an assessment of a particular retailer. This week we will look at the Gap.

The Gap clearly has problems. On March 1st they announced a 35% drop in fourth quarter earnings and a 7% decline in comp store sales. This is will be the third consecutive year of earnings declines. In fact, over the last 32 months, going back to June of 2004, the Gap has only posted three months with positive comp sales. So that is negatives on top of negatives on top of negatives.

In January, CEO Paul Pressler was forced to resign. In February, the Gap announced it was shutting down its experimental new concept Forth & Towne.

What’s going on here? Well, some of the problems are caused by external factors and some of the problems are caused by internal management shortcomings. Of course, the fact that management did not adequately address the external factors would imply that all of the problems are ultimately the result of poor management.

Let’s look at some of the factors that got the Gap in trouble, and then we’ll talk about potential ways to get out of the mess.

External Problem #1: Apparel Woes
It’s tough to make money in apparel these days. Even the Limited has pretty much given up on trying to make a living selling apparel. Here are some of the issues:

1) Apparel is in a long-term disinflationary cycle. That means you have to sell a lot more units just to make the same amount of money (something the Gap has not been able to do).

2) Apparel used to be one of the primary purchases made by people to express their sense of “coolness”—their sense of style, hipness, belonging and individuality. For younger people, that function has now been replaced to a large extent by technology—cell phones, ipods, and the like. Money spent on these devices is often money no longer spent on clothing. For older people, that money is now being poured into their homes like never before. More and more, they are making their statement with where and how they live, rather than what they wear. In other words, if “coolness” and “status” are the attributes sold by the Gap, then their competition has increased to include stores like Best Buy and Bed, Bath & Beyond, who have found another way to tap into those same attributes.

3) The death of the big fashion trend also hurts apparel retailing. We have become such a fragmented society that no one fashion style can capture the market. Large, sweeping changes in fashion do not happen like they used to. Since there is no major fashion trend today, that means that there will not be a major fashion trend to cause it to become obsolete. Hence, the mass need to quickly replenish to stay in style has less power.


External Problem #2: Competitive Woes

1) Forgetting the fact above that the Gap has to compete against more non-apparel retailers for the “coolness” dollar, the Gap is seeing far more direct competition in the apparel retail space than back in it heydays of the last century. JC Penney and Kohls are growing stores like mad. Target has dramatically improved its “coolness” in apparel. Federated stores has revitalized the image of the department stores. An entirely new apparel retail format, called fast fashion (as executed by firms such as Zara, H&M, Forever 21 and Uniqlo) is taking the market by storm (we’ll talk more about this later).

2) Given all of the additional places selling clothing, and given the lack of growth in the sector, something has to give. One is pricing—nearly everything is on sale or bargain priced. The other is value. Clothing has been largely commoditized. When a product is commoditized, it is hard to convince someone to pay a premium for your clothing over someone else’s. Just look at what Steve & Barry have done to licensed apparel. Their prices are low enough to make even Wal-Mart look expensive.

External Problem #3: Shopping Mall Woes

Shopping malls are not the great shopping magnets they used to be. There is too much off-mall competition. Conventional wisdom is that there are only about 200 malls in the United States that still have great drawing power and create great profits for their tenants. The rest tend to be profit problems for their tenants. Unfortunately for the tenants, most of the malls are owned by only a couple of firms. Hence, if you want to be in the good malls, they force you to also be in the bad malls.

The economics of the mall no longer work. The mall rents are too high. You cannot make a profit selling commodity clothing and pay mall rents. The margins are too low. That’s why the Limited has shifted from selling clothing in the mall to selling bottles of goo—something where the ingredients cost a couple of pennies, but they can sell it for $20. That’s why JC Penney and Kohl’s have shifted to an off-mall growth strategy. Being the best in-line mall store is sort of like saying you are the best seller of air conditioners to Eskimos—not much to brag about. And the Gap is nowhere near the best in-line mall store.

Internal Problem #1: Unfocused on Customers

The Gap has been too unfocused in its targeted segment. It has tried to appeal to too many people. In the fashion world, trying to appeal too broadly is the kiss of death. In the past, they have defined their customer as being someone 18 to 35 in age, with no strong distinction of any particular lifestyle within those ages. By trying to be ageless and timeless in their approach, they have become “sales-less” at the cash register.

Internal Problem #2: Wrong Focus on Product/Marketing

1) No matter where you look in retail today, the death is in the middle. Profit is at the extremes. People either want the very best experience or the very cheapest experience. It’s better to be a Neiman Marcus or a Wal-Mart than it is to be a Sears. The Gap is firmly in the middle—the place of death. They charge too much to play on the cheap end and they do not offer enough to win on the high end. The products are firmly in the middle as well.

2) As I mentioned in last week’s blog “Pride of Bag,” retailers are sellers of image as much or more so than they are sellers of product. The goal is to have such a great image that people want to be seen carrying your shopping bag, even if there is nothing in the bag that was purchased at that store. Abercrombie & Fitch is a clothing retailer that made catalogs showing people not wearing any clothing (a catalog not showing the products for sale, but the image being sold). I get the impression from the outside that the Gap still sees itself as a seller of products. They are not focused on creating a Pride of Bag. If all you are trying to do is sell clothing, then you have commoditized who you are, and nobody will pay enough to support mall rent for a commodity.


Assessment/Recommendation

In short, the Gap is selling the wrong product in the wrong place to the wrong people in the wrong way. So how do you fix that? Well there are four potential options:

Option #1: Get Narrow
The Gap can try to narrow its appeal, so that it becomes more meaningful to a smaller segment. After all, it is better to get 40% share of a sub-set of the population than it is to get 3% of a larger population. The problem the Gap has is that it has too many stores to cover a more narrow appeal. That means either shut down a lot of stores, or get narrow over many different segments, creating a portfolio of narrow brands.

Option #2: Go Off-Mall
The Gap can escape the negative economics of the mall by going off-mall. Unfortunately, outside of the Old Navy concept, the Gap really doesn’t have the right kind of a box to optimize off-mall economics. It is too small. Yet, it really would have trouble justifying getting larger. There was a time when the Gap had the opportunity to reinvent itself to become what Kohl’s became. It is probably too late for that now.

Option #3: Create a Mystique that Justifies Paying a Premium
This could work…if you can find the mystique. And it would probably require abandoning the Gap name.

Option #4: Change the Supply Chain

If it’s harder to make money at the retail end, then you need to find ways to fix the problem upstream. This is what the fast fashion people have done. They have reinvented the supply chain. They have shortened the pipeline time, which reduces capital investment and reduced the risk of making wrong guesses. They don’t worry about losing money in markdowns because the batch sizes are too small; they run out before the season ends. They don’t worry about people waiting for a sale, because the customers know that the items will be gone they have a chance to go on sale. Customers come more frequently, because the inventory changes more frequently. And best of all, the shorter pipeline takes out so many costs from the entire business model that one can afford to provide better value and still make a higher margin.

When the Gap is using antiquated supply chain methodologies against this new business model, it is like someone with bows and arrows trying to attack the military sophistication of the United States.

Recommendation

If I were running the Gap, here are the three things I would focus on:

a) I would find the best narrow focus for my company.

b) I would try to be the best destination for the entire lifestyle package for this narrow focus. In other words, I would not define myself as being in the apparel business, but rather in the business of selling a way of life. This would allow me to offer more high-margin goods along side my apparel. Also, it would get me out of the commodities business and into something more highly valued by consumers—self esteem.

c) I would revolutionize my supply chain. Most of the fast fashion retailers have their strength outside of the US. The Gap still has a chance to own the fast fashion space in the US. It lost the window on being the next Kohl’s. Now it has another chance, but the window is closing.

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