Fool.com: Gap: The Challenge of Branding Basics (Fool On the Hill) September 1, 1999

FOOL ON THE HILL
An Investment Opinion

Gap: The Challenge of Branding Basics

By Louis Corrigan (TMF Seymor)
September 1, 1999

The stunning rise of Gap Inc. (NYSE: GPS) to retail superstardom status in recent years has come courtesy of a number of initiatives. Not the least of these is the artful way CEO Mickey Drexler launched and rapidly expanded the firm's Old Navy discount chain while revamping Banana Republic for the higher end of the mainstream apparel market. These moves have created a three-tiered attack that's been unbeatable in sucking customers away from competitors in each segment of the company's expanded market. It's also enabled Gap Inc. to focus each unit's merchandise and revamp inventory management to offer a deep selection of core products, thus boosting sales and improving customer satisfaction.

Nonetheless, the Gap wouldn't have become the ubiquitous pop culture touchstone that it is today without advertising. Actually, massive amounts of hip ads that have managed to turn commodity products (apparel basics) into branded items that get people feeling good and paying up. And that's the idea since customers will seek out the well-branded product rather than accept ready substitutes -- and also pay a premium for that product. The numbers alone paint the general picture. Ad spending has soared from $96 million in 1996 to $175 million in 1997 to $419 million in 1998. Even noting that total sales increased 71% between FY96 and FY98, the uptick in ad spending is striking. The ad budget has risen from 1.8% of sales in 1996 to 2.7% in 1997 to 4.6% last year. The company reportedly aims to hike ad spending to 5% of sales this year.

This aggressive ramp-up on advertising reflects a major shift that occurred during the latter half of 1996. As Fortune magazine pointed out in an August 1998 cover story, Drexler had been preoccupied with expanding Old Navy while repositioning Banana Republic when he realized that the core Gap chain had lost its focus. This was most evident in print ads that featured a male model with an androgynous look and an obvious attitude problem. "It was so incompatible in my mind with what made Gap right," Drexler told Fortune. Shortly thereafter, Maggie Gross, the company's longtime ad director, resigned. That in turn led to the departure of other folks in Gap's ad department.

Drexler refocused on the flagship Gap chain, but now with the aim of answering those critics who felt like the retailer was mature and offered only moderate growth opportunities. He began comparing the overall company to Coca-Cola (NYSE: KO), which has masterfully combined one of the strongest distribution systems on the planet with exceptional brand marketing. "We started to think about our business in different terms," Drexler told Fortune. "Before, for example, we would have had one store in a particular market. But if you think about great brands in America and the world, they usually dominate a much larger percent of market share than any apparel company does."

So Drexler decided to become more aggressive about opening new stores. The company also reevaluated the type of marketing it needed in order to become a truly ubiquitous consumer brand. In April 1997, the Gap launched its first TV ads in more than five years.

Part of expanding the company's market share, though, meant refocusing on basics while going easy on the fashion component. Fashion, after all, is almost inevitably hit-or-miss and thus presents inventory risks. Moreover, too much fashion can dilute the company's mainstream appeal, confusing the very customers that the Gap needed to become the no-brainer first choice for casual apparel.

For all of these reasons, last year's "Khaki Swing" TV ads have got to go down as one of the most successful ad campaigns of the decade. By combining a Louis Prima classic with innovative stop-action filming techniques and a cool-looking but still clean-cut group of dancers, the Gap managed to turn perhaps the most boring of basics into an actual fashion item that drove traffic into its flagship stores.

Of course, it didn't hurt that the campaign took direct aim at Levi's wildly successful Dockers franchise, which had been riding the business casual trend in men's apparel. Moreover, according to industry data, customers buy two tops with every new pair of pants they purchase. That makes pants the optimum vehicle for generating not just traffic but added sales. Indeed, it's just hard to imagine an ad campaign that could have been more appropriate both as a branding enterprise and as a sales driver.

The lingering question, though, is can the Gap keep it up? After all, at some point, customers don't need to buy as many new khakis as they have in the recent past, even with the continuing trend towards business casual. And when everyone's wearing khakis, even the modest cachet they held begins to fade. It's pretty easy to start hating khakis.

Moreover, how can the company continue to offer modest amounts of fashion without either growing stale or going overboard? When I see the dozen or more flavors of cargo pants, I think here's a phenomenon that cries out for a postmodern Marxist critique. There's just a process of hyper-differentiation at work here that embodies both the fetishizing of the commodity and the exhaustion of that fetishization. Cargo pants were a great idea, but that's one idea that's now run its course, in my opinion. What comes next? Though I'm focusing on the Gap chain alone, Old Navy, in particular, faces the same problem of constantly refashioning the basics. That's a challenge Coca-Cola really doesn't face.

It's also a problem that's recently hurt the Gap's stock. Second quarter comp store sales reported August 12 rose a solid but modest 8% after swinging to a 19% gain a year ago. July comps reported August 5 were particularly weak, registering merely a 2% gain versus a 19% increase a year ago. Gap chain store comps were the weakest link in these tallies, simply indicating the high hurdles created by the company's success over the last two years.

What's striking here are the limitations of advertising. A visit to Gap's hometown of San Francisco proves just how well the company manages its blanket ad campaigns. You simply can't travel a mile in the city without encountering outdoor signage that reflects the Gap's casually hip models sporting vests. And personally, I like the new TV ads for the vests featuring a group of Gap-pies singing Madonna's "Dress You Up (In My Love)." In fact, I'm particularly smitten with the young woman featured near the end ("...all over your body..."), which I'd say makes it a successful ad except that she offers a rather too powerful distraction for me.

But vests? You might need vests in San Francisco but you don't need them in Atlanta anytime soon. Also, unlike khakis, a vest whispers fashion. So it doesn't lend itself particularly well to driving store traffic or additional sales since folks who buy a vest don't necessarily buy pants as well. On the flipside, though, the focus on basics alone makes it easy for others simply to trade off of the Gap's brand, where the relatively generic merchandise becomes highly dependent on the marketing for its appeal. Apple's (Nasdaq: AAPL) iMac ads in the CompUSA (NYSE: CPU) window in San Francisco can be easily mistaken for Gap ads, for example.

None of this means that Gap Inc. isn't a great company. It is. The company still managed to grow sales 29% in the second quarter to $2.45 billion while boosting earnings by 47% to $0.22 per share. And Old Navy and Banana Republic are still relatively early in their life cycles relative to the Gap chain itself. Still, investors might ponder whether the Gap's terrific marketing may now be coming up against decreasing returns, in part because it's already been so successful and in part because, well, apparel retailing ultimately depends on the apparel.