Fashion retailers operate in one of the most difficult competitive environments in the entire economy. With no sustainable competitive advantages, companies in this industry must design new products to stay ahead of fashion trends while keeping an eye on efficiency of production. This is a difficult balancing act, but a few retailers have been able to achieve it.
For instance, The Gap Inc. (NYSE:GPS) is known for its prudent inventory management despite some merchandising missteps in the past. At the same time, Limited Brands, Inc. (NYSE:LTD) has been able to generate good returns from its signature Victoria’s Secret and Bath & Body Works brands, while keeping expenses low. Meanwhile, Abercrombie & Fitch Co. (NYSE:ANF) has carved out a niche that allows it to thrive.
The long-term success of each of these companies ultimately comes down to efficiency. As part of its effort to achieve efficiency, Abercrombie sells its products at a higher price point than The Gap Inc. (NYSE:GPS) and Limited Brands, Inc. (NYSE:LTD).
Abercrombie’s higher price point allows it to earn higher profits during good times, but lower profits during bad times. This is because price-conscious consumers often favor lower-priced apparel when their income is down. As a result, of operating leverage — a cost structure that mainly consists of fixed costs — Abercrombie’s net income is extremely sensitive to consumer income levels.
Another crucial metric of a retailer’s efficiency is inventory turnover. A high turnover ratio indicates that the retailer is able to replenish its inventory several times per year. Good inventory management limits a retailer’s downside in the event that the wrong trend is stocked in stores.
Limited Brands, Inc. (NYSE:LTD) and The Gap Inc. (NYSE:GPS) manage their inventory better than Abercrombie. This is because the two companies have worked to shorten lead times on ordered merchandise and maximize sales per square foot. Both companies have had merchandising mishaps, but neither were severely affected due to prudent inventory management.
Finally, investors should always consider a retailer’s cash conversion cycle. The cash conversion cycle measures how long it takes the company to acquire and sell inventory, collect accounts receivable, and pay accounts payable. A lower number indicates that the business quickly turns inventory purchases back into cash, whereas a higher number indicates a longer time between initial inventory purchase and re-conversion to cash.