Who's the Most Adaptable Retailer?

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The holiday season of 2008 may go down in history as one of the biggest nail-bitters in the last few decades. Motley Fool analysts have assessed the state of retail going into this critical season -- the stocks, sales strategies, consumer trends -- and identified the winners and losers at the mall and in investors' portfolios. Click here for the complete report.

Don't blink, or you might just miss the next big fashion statement. No one knows this better than Spain's Inditex. And perhaps no one is more clueless than Gap (NYSE: GPS). Ironically, the two are duking it out for title of world's largest retailer.
Innovation isn't limited to tech companies such as Apple (Nasdaq: AAPL) or Google (Nasdaq: GOOG). In fact, innovation is a vital element for running a successful retail business -- or at least one that will be successful over the long run.

Rapidly changing fashion trends require retailers to respond quickly to fresh-off-the-runway looks. Even brands such as American Eagle (NYSE: AEO) and J. Crew, which target a preppy crowd that's less sensitive to "in" styles, must continually innovate to keep up with shoppers' ever-changing fashion tastes.

Just like chasing a hot tech trend on the rise, investors have learned harsh lessons from investing in booming fashion fads. Companies built solely around a one-hit wonder fashion craze never stick around for long. Those who jumped on the Crocs (Nasdaq: CROX) and Heelys bandwagons are holding stocks that are so yesterday -- and so not last year's price.

That brings me back to Inditex, better known for its Zara brand. Inditex is the epitome of fast fashion, an up-and-coming trend among young shoppers. Splashing the word "Abercrombie" across the front of a sweatshirt isn't catching on anymore, the way it used to work for for Abercrombie & Fitch (NYSE: ANF). Teens and young adults want cheap chic clothing that sets them apart from their peers. They want to look like the model who walked down the runway in Milan five minutes ago.

Inditex has gotten as close as possible to delivering this option to its customers; the company can move designs from sketchpad to store shelf in just two weeks. And by instructing store managers to monitor sales on a daily basis, the company has created a business model that allows them to alter their styles literally in real time. The company has become wildly successful with its strategy of maintaining low inventory levels and creating a sense of urgency for its shoppers. A design hanging on the rack today may not be there tomorrow.

By using this method, Inditex nearly eliminates fashion risk from its business, since it has developed a reputation for selling the most "in" styles. Further, it doesn't have to offer heavy discounts to clear out stale inventory. Thus, it's no wonder the company maintains net margins superior to those of many of its competitors, including thriving rivals such as Urban Outfitters (Nasdaq: URBN).

Consumers are very fickle, and retailers who lack the expertise, ability, and willingness to change with their clientele will ultimately fail. Those that rely on one single "hot" product will quickly crash and burn. Choosing retail investments for the long run requires looking well beyond the financials and the near-term prospects for a company. Never forget -- a product can fall from grace as quickly as it rose to fame.