Francesca's Holdings (NASDAQ:FRAN) is a rarity in the cutthroat world of fashion retail, given its consistent profitability and strong revenue growth. It has consistently delivered an operating margin of more than 20%; while its specialty-retailing peers like ANN and Urban Outfitters sport margins in the low- to mid-single digit range.
The story for revenue growth is similar, with Francesca's increasing its top line by a three-year compound annual growth rate of 55%. There are striking similarities between Francesca's business model and that of other successful retailers like Costco Wholesale (NASDAQ:COST) and Steven Madden (NASDAQ:SHOO), which I will examine below.
Shallow and exclusive
Francesca's has a 'shallow and exclusive' approach when it comes to its assortments. In many ways, this is very similar to the strategy adopted by warehouse-club operator Costco.
Firstly, Francesca's calls its assortments shallow because it chooses to stock up only a limited quantity of each product. Costco's warehouse-club model also thrives on having fewer SKUs (stock keeping units). Both Francesca's and Costco benefit from keeping their merchandise 'new and fresh,' drawing customers back in stores for the latest trending products. This is particularly relevant for Francesca's, as fashion risk, where unpopular merchandise is overstocked relative to customer demand, is minimized.
Secondly, while Francesca's peers focus on third-party national brands, unique merchandise carried under its proprietary labels accounts for a large proportion of Francesca's mix. The exclusivity of Francesca's items suggests that it doesn't have to compete on price with other retailers with respect to 'me-too' products. Similarly, Costco also relies strongly on its private-label products to drive customer loyalty. A recent Consumer Edge Insight survey showed that consumers expressed the greatest amount of satisfaction with Costco's house brands among 25 retailers.
The financial numbers speak for themselves. Both Francesca's and Costco have high inventory turnover ratios. While Costco turns over its inventory every month, or about 12 times a year, Francesca's held its inventory for an average of 45 days in fiscal 2013. This is largely attributed to its 'shallow and exclusive' merchandising strategy.
Fast, but not so fast
In fashion retail, it is very dangerous to be either too far ahead or behind the curve. The former leads to an overestimation of customer demand, while the latter means that all of the profits have been taken off the table. That's why Francesca's positioning as a 'fast follower' is valuable.
Once the latest fashion trend gathers momentum, Francesca's is quick to meet customer needs with its short lead times of between four and 12 weeks. This is made possible by having a diverse supply network of more than 400 U.S.-based vendors. As a result, Francesca's is able to have new merchandise delivered to its stores five days a week, as customers keep coming back for new products.
Speed-to-market is a key competitive advantage, and footwear and accessories retailer Steven Madden understands this as much as Francesca's. Its unique test and react 'supply chain strategy' allows it to achieve shorter lead times of six to eight weeks, compared with the industry norm of three to four months. The key lies in Steven Madden's small sample factory at its headquarters, which enables it to launch a prototype and send the shoes to selected stores within days. If customer response is positive, Steven Madden gives its overseas vendors the go-ahead to start mass production.
While Steven Madden has lead times comparable to that of Francesca's, Francesca's has an edge because its shallow merchandising strategy fits very well with its fast-follower positioning. A faster inventory turnover allows Francesca's to put new products on shelves quickly.
Foolish final thoughts
Pattern recognition is a useful skill to have in identifying profitable companies, as they tend to share common elements accounting for their successes. Francesca's,'shallow and exclusive' merchandise and fast lead times are the same things observed with other peers like Costco and Steven Madden. This is by far the strongest validation of Francesca's business model and its future success.
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Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.