How This Retailer Minimizes Fashion Risk

Fashion risk essentially means offering out-of-favor products to your customers when market trends point to something totally different. Express (NYSE: EXPR  )  initiated what it calls a 'go-to-market' strategy after it was sold by L Brands in 2007 to minimize fashion risks.

Ready to pounce on opportunities
The mantra "cash is king" doesn't just apply to stock investors. In fashion retail, there's an important concept called Open-To-Buy, or OTB, which is the difference between how much inventory you need and the actual amount you have. In other words, this is the amount of spare cash that retailers have on hand so they can react to new fashion trends. This is very similar to how investors don't stay fully invested (keeping cash in a portfolio) to pick up bargains during severe market downturns.

Express intentionally sets aside OTB dollars to take advantage of opportunities for in-season inventory adjustments. Based on weekly readings of sales data and monitoring of new product introductions, Express' management convenes twice per month to decide how to utilize OTB dollars. Management also revealed at the January 2014 ICR XChange Conference that they have hired a new Chief Merchandising Officer to optimize the usage of OTB dollars.

Express' peer Francesca's (NASDAQ: FRAN  )  applies this concept of a buffer in a slightly different manner. It chooses to stock only limited quantities of each SKU, or stock-keeping unit. If Francesca's gets its merchandising strategy wrong, it can easily replace unpopular products on the shelf with new ones. In fact, Francesca's brings new trending merchandise to its stores every day. Its 'shallow' merchandising strategy fits in perfectly with its fast-follower approach toward chasing trends and its short supply chain lead times of between one and three months.

Be it by holding excess cash or making space for new inventory, the underlying idea is for retailers to be as flexible as possible in the face of changing market trends. Conversely, cash-strapped retailers with their shelves full are most vulnerable to fashion risk.

Test first, react later
Express also doesn't rush to make orders after analyzing sales data and checking the amount of OTB dollars it has on hand. Instead, it tests out three quarters of its new products in selected stores before launching them across all its stores. For example, a long-sleeved stripe knit tee targeted at the Express girl was tested in October 2013 and it had brisk sales in November and December. Looking ahead, Express has ordered large quantities of this SKU for sale in the spring season.

Again, it is possible to draw parallels here with another retailer, Steven Madden (NASDAQ: SHOO  ) . Steven Madden's 'test-and-react' supply chain model allows it to make a prototype of its new shoes at its sample factory which is ready for sale within days. Thereafter, the company closely watches sales data and gathers feedback from staff and customers to assess the sales potential of these new shoes.

The success of Steven Madden's 'test-and-react' strategy is validated by its market share and growth trajectory. It is ranked second and third in juniors' and womens' footwear categories, respectively, in terms of market share, according to NPD Group data. In the past six years, Steven Madden has also grown its earnings by a compound annual growth rate, or CAGR, of 34%.

By testing new merchandise before launching the products nationwide, both Express and Steven Madden minimize their potential of financial losses caused by product failures.

Narrow focus
It is very easy to get fashion wrong when you define your target customer base too broadly.

Express defines its target customer as a 27- year-old Express guy and a 23-year-old Express girl. While it obviously sells to a wider customer demographic, this narrow definition keeps Express focused. By defining a customer with a specific age, the customer profile becomes real and concrete, leaving no room for second-guessing by Express' marketing department. Does the 27-year-old Express guy like a baseball T-shirt? Does the 23-year-old Express girl like high-rise shorts? When a certain age is fixed, marketers are more likely to find the right answers.

Foolish final thoughts
Since it successfully applied elements of its go-to-market strategy in 2007, Express has seen a significant improvement in its financial performance. Its gross margin has expanded by 930 basis points from 25.3% in fiscal 2008 to 34.6% in fiscal 2013 while its revenue grew by a three-year CAGR of 7.7% from 2011 to 2013.  This validates Express' success in minimizing fashion risk.

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