How Gap's Focus on Brand Made the Difference

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Over the past year, Gap (NYSE: GPS  ) has undertaken a massive turnaround. From the beginning of 2005 to the start of 2012, Gap's stock had dropped 13%. The company had become the fashion equivalent of white bread -- everyone had it but no one cared about it. Then everything changed. Management refocused on the core brands, changed the way that design was approached, and worked out the kinks in production. Since the start of 2012, the stock has risen 65%, and Gap seems to be back on top.

There's still lots left in the tank, and the company has managed to climb to new heights by doing something seemingly simple -- it focused on its core strengths. No diworsification, no brand-new business lines, no learning to love again. Just a simple single-mindedness that we could all learn from.

Demanding performance from the core brands
In its lackluster years, two of Gap's brands became muddled. Gap and Old Navy both sell similar sorts of merchandise, with Gap products occupying a slightly higher tier of quality. But that division broke down when Gap used cheaper materials in its products and started to fall behind in time to get new product to market. The brand quickly fell in customers' eyes, and sales walked out the door. To correct that problem, Gap spent most of 2012 redefining its eponymous brand.

As a result, the company moved away from discounting merchandise, an in the last reported quarter, gross margin was up 4 percentage points to 41%. The success of the rebranding also meant that Old Navy became more differentiated. That resulted in the largest revenue increase across the three brands, with third-quarter revenue up 9% on comparable-store sales of 9%.

If there's a scenario that can highlight the reverse of that brand strength, it's Coach's (NYSE: COH  ) last quarter. The handbag retailer still has a strong brand, but its holiday sales were rough. For a big part of the shortfall, we can point to Coach's management team as they took their eye off of the company's core product line. While men's and international sales did well -- up 50% and 12%, respectively -- sales of women's handbags in America sank. That dragged the whole business down for the quarter and resulted in a dragged-down comparable sales of 2%. Clearly, the company has a little work to do, though with a gross margin still over 70%, it shouldn't be too much work.

Expanding the range, not the type
The focus that Gap had and which Coach lacked came from knowing what it did best and tweaking those areas. Even in its expansion, Gap managed to play it safe. The biggest push last year came from the company's Athleta line, which challenges lululemon athletica (NASDAQ: LULU  ) for yogawear sales. The business segment containing Athleta increased revenue by 31% last quarter. Earlier this year, the company completed the purchase of Intermix, a high-end clothing retailer with locations across the United States. While the Athleta brand is sporty and Intermix is high-end, both are simply versions of the apparel store.

Looking again at Coach -- which, honestly, I do like -- investors can see the problems that come with overdiversifying. In one period, Coach wanted to grow its international business and its brand-new men's line. Both did grow, but the energy and resources taken to expand in unknown cultures and to market to a whole new customer group meant even less was focused on the core business.

Smart overseas growth
Finally, Gap's focus on its core has given it a new way to focus on international growth, while companies such as Lululemon have been very slow to move internationally. Lululemon thinks about international expansion in the same way that it thinks about American growth. First it feels the country out, then it puts down a showroom, then it sees what interest is like, then it builds a distribution center, and on and on the list goes. It's not a bad way to expand -- in fact it's a very safe way to expand -- but it is mind-numbingly slow. The company wants to begin "pre-seeding activities" in 15 countries over the next two years. Great, but how is it going to sell the actual product?

The heavy focus on operations means slow-moving expansion. Instead of taking that approach, Gap has realigned its businesses around the brands. The manager of Banana Republic in the U.S. manages Banana Republic in Europe as well. The obvious risk is that the manager knows only one region and missteps in the expansion. But the upside is that the company thinks about brand before it makes moves in new countries. That means a better customer experience and stronger sales for Gap.

I'm expecting this week's earning release to be excellent, and I'm going to be looking for international growth from Athleta and domestic growth from Intermix throughout 2013.

lululemon athletica has the potential to grow its sales by 10 times if it can penetrate its other markets like it has in Canada, but without question, the competitive landscape is starting to increase. Can Lululemon fight off larger retailers like Gap and Nordstrom, and ultimately deliver huge profits for savvy investors like yourself? The Motley Fool answers these questions and more in our most in-depth Lululemon research available for smart investors like you. Thousands have already claimed their own premium ticker coverage, and you can gain instant access to your own by clicking here now.

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