Indian apparel retailers have been overly focussed on top-line revenue growth rather than expanding their bottom-line.
In their drive to convert customers and increase store count, Indian apparel retailers have paid too little attention to how they will achieve the higher levels of profitability that will be necessary to sustain a winning position over the long-run. As a result, insufficient priority has been placed on the two levers of margin expansion: achieving higher sales and lowering the cost of goods sold.
By contrast, the most profitable global apparel retailers like Zara, H&M, and Uniqlo - who are now making inroads into the Indian market - have put superior business economics at the core of their business models. They have achieved this by driving cost out of the supply chain at the same time as delivering a clearly differentiated customer experience. Such successes have yet to be achieved by Indian apparel retailers but, by taking action on the key levers of margin expansion, they can get on the path to improved profitability.
The first front for improving the business economics is increasing sales. Apparel retailers can increase sales on a like-to-like basis by increasing their sales density (sales per square foot), protecting their MRP price, and gaining the capacity to increase prices without reducing volumes. To achieve these objectives Indian apparel retailers need to focus on four key areas for improvement: i) increasing their differentiation ii) switching from a simple push to a push and pull supply model iii) employing better mark-down management and iv) improving customer engagement.
When the product and experience are weakly differentiated from other players competing in the same segment, the customer will only compare in terms of price. Thus when one player discounts to shift slow-moving stock or increase sales, the other players are forced to follow suit, destroying value across the sector. This is the prevailing scenario in Indian apparel retail.
To effectively differentiate, retailers need to deliver a unique combination of product offering, price point, and customer experience. But to do this they first need to decide in which customer segment they want to play and then develop the proposition that will be most highly valued by these customers. Today Indian retailers have yet to effectively target discrete customer groups, with most offering a largely generic range of men's western casuals and formals. But as the Indian consumer market becomes increasingly fragmented, customers are looking to express themselves in distinct ways. In such a scenario continuing to try and be all things to all people is a recipe for failure.
For example, an older customer that buys according to quality and customer service is likely to be unsatisfied by a store that promotes fashionable items on young models and is staffed by young attendants. Alternatively, teenagers and students looking for casual wear will be put off by extensive floor space dedicated to office wear and older attendants dressed in formals.
But being targeted doesn’t mean that the retailer remains small. Zara is a multi-billion dollar enterprise but clearly focusses on a younger fashion conscious consumer with its core format, developing other concepts like Kids or distinct brands like Massimo Dutti (luxury) for other segments. Similarly, Uniqlo’s single format model ignores the highly fashion conscious consumer and focusses on those who value great functionality and affordability in their garments.
Critical to achieving a differentiated positioning is the consistency of its application across every aspect of the customer experience; from the look and feel of the stores to the level and type of customer service and the convenience of the channel.
However, in transforming a unique strategic positioning into a truly differentiated experience, the moment of truth is the customer interaction with the retailer’s staff on the shop floor. Store staff are vital to converting walk-ins to customers, cross-selling new products and upgrading them to higher value purchases. What is more, they acquire numerous insights on customer behaviour and feedback that are invaluable to the organisation. All of this is critical to the achievement of higher sales.
The quality of the customer interaction is a persistent area of weakness for Indian apparel retailers and a great opportunity for players to achieve differentiation. With staff representing a low percentage of total expenditure and the high availability of low skilled labour in India, this critical component of a retail organisation is treated on a commodity-like basis. The inevitable result is low employee engagement and high attrition rates, with retail managers and store staff trapped in a cycle of mutual dissatisfaction. The net effects are false economies in operating costs that actually mask a mountain of lost sales and unhappy customers.
Tackling this weakness requires appropriate organisational design along with proper internal communication and decision-making systems. It also needs incentive programmes that recognise success beyond simple financial rewards, and meritocratic models for promotion that reward loyalty to the organisation over the long-term. These systems and processes need to be transparent and supplemented by ongoing training and development at the store and head office level.
Switching from a simple push to a push and pull supply model
Apparel retailers need to move away from the current practice of push-based supply to a more intelligent system of push and pull. Today many retailers are waging an ‘all in’ bet on the next season by placing their complete orders in advance. The impossibility of accurately predicting the next season’s fashion trends, weather, or consumer confidence, inevitably results in slow or non-moving stock that must be sold at discount, bringing down the gross margins.
Instead, retailers should break the season down into shorter periods and break the product range down into different categories according to their predictability. For example, by breaking the season down into shorter planning cycles, retailers can continually test the customer response to say a style or colour and place further orders accordingly for the next ‘mini’ season. As a result, the downside of a bad call in merchandise planning is limited to a much smaller amount of stock.
These shorter planning cycles should be supported by a clear break-down of the product range according to their fashion quotient. For example, a simple segmentation could be into basic, basic fashion and fashion items. These categories are defined by whether their predictability of demand is high, medium or low. For example, basic items like simple white shirts, t-shirts, and inner wear might see very little variation in demand from season-to-season. These items can be ordered further in advance and in larger quantities. As the fashion quotient increases, the more fickle the customer response will be. Therefore more fashion oriented items should be ordered in smaller quantities with shorter lead times, giving planners sufficient wiggle room to adjust their orders.
To implement shorter and more agile planning cycles retailers must create dedicated internal planning teams that are constantly monitoring the latest global and Indian trends. There also need to be systems in place to regularly communicate information back from store staff and customers to inform these planning decisions.
Employing better mark-down management
Even when inventory is under control, Indian retailers can fall into the trap of marking down prices due to pressure from competitors, producing a negative impact on income. Whilst a strongly differentiated value proposition will help persuade customers of a brand’s superior value, retailers need to maintain discipline in mark-downs to protect their margins.
Key to mark-down management is having a proper mark-down plan in place ahead of the season. Retailers should consider in advance which products they are willing to discount and by how much. This should be integrated with their financial planning for the season, so they are fully aware of the implications of mark-downs on their profitability at both the chain and category level.
Secondly, retailers need to be proactive in their use of mark-downs to avoid having to clear large amounts of stock at the end of the season. If a line is selling slowly, incremental price reductions in-season can help clear inventory, without the need for aggressive sales across all product lines at the end of the season.
Finally, planning the dates for major yearly or twice yearly sales and building a marketing plan around them will help optimise the mark-down process. Retailers can project the amount of discounts and the likely uptick in sales volume and thus estimate an appropriate marketing budget to invest during the sales period. Well-planned and executed sales can actually drive profitability through dramatically increasing volumes at key points of the year. By combining effective marketing communication about the sale with attractive discounts targeted at loyal shoppers, sales can also become a valued element of your proposition to your most profitable customers.
By employing these techniques sales are no longer a necessary evil but an integral part of the retail strategy, contributing to both profitability and customer excitement about the brand.
Improving customer engagement
While a clear differentiation will attract customers to the brand, retaining and upgrading them requires retailers to engage them in a targeted way. Here measuring customer loyalty is an essential first step which that many Indian retailers have yet to take. But managing loyal customers must go beyond simply issuing cards and giving points. Loyalty programmes need to be used to identify and segment the most loyal - and profitable - customers. They then need to be given interesting targeted offers and services. As retailers grow their capabilities in loyalty management, analytics become a powerful tool, enabling them to send highly personalised offers to individual customers according to their recent purchase behaviour.
These technology-based loyalty tools are insufficient though if they are not supported by the right actions of store staff at the critical moment of truth. In our research conducted at a number of national retailers, we witnessed how store staff regularly missed opportunities to engage customers and convert walk-ins into billings, and how in some cases they even alienated and offended their clientele. Addressing these ‘breakpoints’ by training staff in the correct techniques for customer engagement will significantly increase conversions and customer satisfaction.
Furthermore, the most loyal customers must receive enhanced service by store staff and managers or else they will remain underwhelmed. In this regard lessons from the hospitality and travel industry are particularly valid, where top airlines and hotels ensure their staff are fully briefed about the personal preferences and requirements of their most loyal customers, enabling them to give them special recognition and treatment.
Reducing the cost of goods sold (COGS)
The second front for improving the business economics in Indian apparel retail is reducing the cost of goods sold. This will be achieved through i) the right sourcing strategy, ii) investing in and integrating the supply chain, and iii) increasing the share of private label.
Firstly, Indian apparel retailers need to get their sourcing strategy right. This involves identifying the best value suppliers whether in India or abroad. For example, manufacturing costs in neighbouring Bangladesh are 20 percent lower compared to India. In 2012 Bangladesh’s total apparel export was $22.2 billion compared to India’s $12.9 billion1, resulting in larger scale manufacturers more attuned to international requirements. In recent years steadily rising garment imports from both Bangladesh and Sri Lanka show the increasing competitiveness of imported products versus locally manufactured garments. Imports from Bangladesh and Sri Lanka grew at a CAGR of 90% and 61% respectively between 2008 and 2012, compared to 23% growth of total apparel imports during the same period.
In addition to making the right sourcing decisions, retailers need to make substantial investments in their supply chain to improve the speed and quality of production, which will further lower the costs of goods over time. At present, the lead time for many Indian suppliers is 4-6 months - far too long to respond to changing consumer trends. But to make the necessary investment in machinery, technology, and systems requires long-term strategic collaboration with suppliers. These kinds of partnerships will demand commitment, substantial financial investment and a collaborative approach from the retailer.
Finally, increasing the share of private label products is a critical step to reducing the cost of goods sold. The most profitable global retailers such as Zara, Uniqlo and H&M are almost exclusively private label retailers. In a highly competitive market, paying higher prices to brands is margin-eroding and the indirect investment in their brand dilutes the retailers’ standalone brand equity. Globally, multi-brand apparel retail is the domain of premium department stores, online retailers or local boutique stores. The first can maintain margins due to the high price of the product as well as commanding rentals for shop-in-shop concessions. Secondly, lower infrastructure costs allow e-retailers to preserve profit margins. While smaller stores serve niche local markets and lack the scale to source their own product.
Indian apparel retailers need to develop a clear plan for building a capability in private label, from developing an integrated supply chain through to better understanding their customers’ needs.
With the low profitability of many Indian apparel retailers threatening to undermine their long-term survival, the priority of the moment is a relentless focus on achieving margin expansion. Although this is a significant challenge it is by no means insurmountable. By thinking rigorously and innovatively around the levers of sales and cost of goods sold, retailers can identify areas to sustainably grow their profits.