‘Margin-eroding’ strategy hurts Lululemon profits

Lululemon begins its new fiscal year in very much the same way it ended its last one: strong overall sales growth fueled by the rise of online and the opening of new stores, with softer comparable growth.

While underlying sales growth at stores is positive, and has improved on last quarter, it remains weak – especially in light of the fact that in the prior year same-store sales fell by 1 per cent.

The failure to drive growth through stores continues to impact on Lululemon profits, which at operating level were down 15 per cent. The direct operation has cannibalised sales from shops and, while it is a necessary and vital part of the company’s strategy, it is margin eroding. This impact has been exacerbated by the various investments Lululemon has been making in opening new locations and concepts, as well as in product design. These investments are sensible, but they take time to deliver and, as such, act as a short term drag on earnings growth.

That is not to criticise Lululemon for making the investments. Indeed, they are being vital in helping the company to thrive in a marketplace that continues to become more crowded and competitive. This, as we have seen over recent quarters, has made attaining growth more of a challenge and means that Lululemon has to work much harder to stand out and stimulate loyalty – especially as it comes up against the aggressive expansion of Under Armour.

Much of the future focus is, rightly, on products – an area where Lululemon has stumbled in the past. Initiatives like Engineered Sensation – which divides the pants range into a variety of different feels or sensations – are sensible in terms of getting shoppers to upgrade or buy new product. They are also vital in keeping Lululemon at the forefront of sports innovation, an area where Under Armour has already made strong inroads.

No matter how much innovation Lululemon puts into its products, its rather limited core offer does restrict how many consumers buy into the brand and how much those that do end up purchasing. For this reason the company is right to diversify beyond its traditional base. The expansion into menswear is going reasonably well and there is no doubt that Lululemon is gaining ground in this space, however our view is that given the embryonic nature of this part of the business growth is slightly soft. We also believe that Lululemon has a lot more work to do in building its brand image with male shoppers.

Stores are also an area of future focus, and we are encouraged by the fact that Lululemon understands that more work needs to go into making these community hubs and places of inspiration. This is something that Under Armour, especially in its larger Brand House stores has done to great effect and in so doing has raised the bar of expectation. In many locations, Lululemon is now playing catch-up.

However, there are signs that the company is getting its house in order, especially in larger stores including the Flatiron store in New York. Here the Hub 17 concept provides space for workshops, community events, and classes. It is a model that Lululemon could roll out, albeit in a more diluted way, across other locations.

The recent opening of a new Lululemon Lab store in New York follows on from the success of the format in Vancouver. These stores are, essentially, design spaces where creatives produce and sell limited edition product made on short production runs. While the concept is niche and will never be a large part of Lululemon’s overall business it helps the company achieve two important goals. Firstly, to fuel innovation and ideas for the mainstream business; and secondly, to help promote Lululemon as an engaging and cutting edge brand with a distinct point of view. There is potential for more of these stores in large US cities and in key global cities like London.

With the various things it is doing, Lululemon is striving to compete more effectively in a more challenging market. However, while continued store openings and online growth can quickly drive top-line sales, the other initiatives will take a little more time to deliver through in terms of comparable sales and underlying profit.

  • Neil Saunders is CEO of retail analyst Conlumino.


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