Gap Fights Discounting With Operational Rigor

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It's fair to say Gap (NYSE: GPS  ) has had a stonking year. The company has grown revenue, earnings per share, and comparable sales. Its Athleta business is growing at a rapid clip, and its Intermix brand is getting fired up. Internationally, Old Navy is expanding into Asia and growing its South American franchise businesses. Great.

Now, where do we go from here?

Gap's war on promotions
Gap shifted a few things in its third quarter this year. Most notably, the company has opted not to go back to television in the fourth quarter, which cut some costs out of the third quarter. While the company didn't go into detail behind the shift in media mix, its intentions were clear from the earnings call.

CEO Glenn Murphy was bombarded by questions pertaining to the promotional environment this holiday season. As we're in the midst of retail-earnings season, there are plenty of examples for analysts to turn to. Earlier yesterday, Target (NYSE: TGT  ) announced it was going to jump into the promotional lead-up to the holidays with both feet. The company said that in some Northern California stores, it would be running a promotion for 40% off all apparel and accessories for Black Friday weekend.

Murphy doesn't want to be a part of that mentality. By avoiding TV, the company can keep its pricing message clear and timely, without spending big on ads hyping upcoming sales events.

Gap's call for better operational design
One of Murphy's strongest claims on the call was that part of the reason for consumers turning to discounted items as the norm was their fatigue from lazy design. He said that, as an industry, retailers have "not been that innovative in order to give the consumers a value proposition that doesn't look like wallpaper day in day out." Gap wants to do better, and this is where the company starts to lay out its plan for the future.

The approach for Gap is threefold. First, the company wants to design better clothes to get customers excited about buying them, instead of being excited just about getting a deal. Second, Gap is going to broaden its "Reserve in Store" program. The program differs from a pick-up system because customers don't buy the products online; they simply reserve the items online and then pick them up and purchase them in-store.

The final step is the biggest from an operational standpoint. Gap is moving toward seamless inventory management and quicker production. The key is bypassing traditional distribution, which sends products to stores based on store size or some very broad plan -- say, every store gets 100 shirts. In Gap's vision, clothing is distributed based on demand, which helps the company maximize its margins.

The future is operational management
For investors, the benefits of Gap distancing itself from the promotional environment is clear. The company can avoid margin compression while it still grows sales. It also gives Gap a chance to make itself stand out from the rest of the apparel-retailer pack. The plans for seamless inventory won't come to fruition until 2015, but reservations and better design should be in-store soon. Look for Gap to manage its margins over the holiday season, in order to avoid falling in with the rest of the crowd.

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