How Can Abercrombie & Fitch Get Back in the Game?

If you were holding onto Abercrombie & Fitch (NYSE: ANF  ) stock this time last year, you were in a much better position than you are now. While the S&P 500 has risen 20% since the beginning of April 2013, Abercrombie's stock has fallen 17%. Flagging sales across the teen apparel sector have hit almost every major brand. Last year's holiday season was indicative of the rough spot retailers are in, with customers demanding promotional pricing and getting it.

While a few companies like Urban Outfitters (NASDAQ: URBN  ) and Gap (NYSE: GPS  ) have managed to hold their heads above water, most companies are feeling the pinch. Abercrombie's comparable sales have fallen, and the company is forecasting further declines this year. With a world of hurt piling up in its corner, what does Abercrombie have to look forward to?

Abercrombie's speed to market
Promotions are the death knell of once-strong retail brands. Once customers become accustomed to not paying full price for items, it's very hard for them to readjust. Abercrombie & Fitch has seen its margins slowly compress as shoppers continue to hold out for a better deal. In its last fiscal quarter, Abercrombie's gross margin fell on a year-over-year basis. 

In its most recent call, Abercrombie said average unit retail prices -- the average price per item -- would continue to fall as the company tried to be more price competitive. To make that a viable option, Abercrombie will also have to reduce its average unit cost. 

Urban Outfitter's Anthropologie brand, on the other hand, has managed to reduce its reliance on promotions, which has led to an increase in the whole company's gross margin. One of Urban Outfitter's biggest successes has been its reduction in lead time for new products. Fulfillment and shipping times both fell over the last year, helping get the most popular products onto shelves and reducing the need to mark down products that have passed their prime. 

Abercrombie is one step behind Urban Outfitters, and is now working on the first steps to shorten lead times on its products. Cutting down on those lead times is key to the company lowering its average unit cost, which, in turn, is a key to allowing it greater pricing flexibility, which then leads to lower price points and more sales.

Once the transformation is complete, you end up with something that resembles the Gap's process. Gap went through this over a year ago, changing up its delivery system and strengthening its relationships with distributors. That helped the company get products to market quicker and make them more applicable to current trends.

The bottom line
Abercrombie needs to jump on that bandwagon and get people the clothes that they want at a competitive price. That seems self-evident, but it's actually a reversal of the usual system. Normally, Abercrombie & Fitch -- along with every other teen retailer -- would want to be dictating fashion, not reacting to it. With purses tight and hot brands rotating in and out, Abercrombie can't just try to force its way back into dominance.

For a while, the company needs to follow if it wants to get another chance to lead. Following means being reactive, and being reactive means being quick. Over the rest of 2014, investors should watch for Abercrombie to speed up its time to market, cut its costs and prices, and keep its margins relatively unharmed through the process. If it can do all that, things should be looking much better for the brand this time next year.

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