American Eagle Outfitters (NYSE:AEO) recently started testing a new apparel rental service called "Style Drop". The service lets subscribers, who pay $49.95 per month, rent three articles of clothing at a time. The products can then be swapped out an unlimited number of times throughout the month. Shipping is free, and subscribers don't need to wash the clothes before returning them.

Will this strategy widen AEO's moat against fast fashion retailers like H&M and Inditex's Zara? Or will mainstream shoppers balk at the notion of renting clothes instead of buying them?

An American Eagle ad campaign.

Image source: American Eagle.

The business of clothing subscriptions

Clothing rental was previously associated with high-priced apparel like tuxedos and designer dresses. However, several companies started blurring the lines between purchases, rentals, and subscriptions over the past decade.

Ten years ago, Jennifer Hyman and Jennifer Fleiss founded Rent the Runway, a platform that lets customers rent high-end apparel. It currently offers monthly subscription services for $89 or $159 per month. In late 2017, Ascena Retail Group's Ann Taylor launched a similar rental service for $95 per month.

Stitch Fix (NASDAQ:SFIX), which went public in late 2017, charges customers a "styling fee" of $20 and delivers a package of five pieces of clothing based on the results. The customer gets three days to decide to keep or return the items, with the styling fee serving as a credit toward purchased items. The customer can set the frequency of subsequent shipments to once every two weeks, every month, or every two months.

Three young women go shopping.

Image source: Getty Images.

Shortly after Stitch Fix's IPO, J.C. Penney (OTC:JCPN.Q) partnered with Bombfell to launch subscription boxes for big and tall men. Bombfell uses a similar business model as Stitch Fix, but gives customers a longer return window of seven days.

Amazon (NASDAQ:AMZN) also launched a non-recurring Stitch Box-like service, Prime Wardrobe, for all its U.S. Prime members last year. The service lets customers order three or more items without an upfront charge, and has a return window of seven days.

Some of these services don't technically offer "rentals", but some customers likely wear the clothes in public before returning them. Therefore, it makes sense for companies like AEO to launch full rental services, which serve as perpetually rotating wardrobes. AEO could eventually expand its service with Stitch Fix-like purchase options, or offer exclusive discounts on its American Eagle and Aerie apparel.

The apparel rental market in the US (excluding costume rentals) could grow 29% annually to $1.28 billion this year according to GlobalData, so there could be plenty of room for all these platforms to grow.

Why a rental service could help American Eagle Outfitters

AEO has been a "best in breed" retailer in the crowded apparel space. It consistently ranks among the top brands for teens in Piper Jaffray's semi-annual "Taking Stock With Teens" surveys, and it posted 15 straight quarters of positive comps growth.

An American Eagle ad campaign.

Image source: American Eagle.

However, AEO is still heavily dependent on brick-and-mortar stores, and it faces tough competition from fast fashion retailers, which capture shoppers' attention with low prices, data-driven designs, and rapidly rotated collections.

AEO plans to upgrade its online platform, which generated double-digit sales growth for 15 straight quarters and accounted for about 27% of its top line last quarter, with in-store pickups for online orders in the near future. It also recently upgraded its digital call center, automated its distribution facilities, and will transition to an upgraded digital platform in 2019.

Its "Style Drop" rentals could serve as a natural expansion of that ecosystem. Renting out clothes would lock shoppers into AEO's brand, dampen the appeal of fast fashion apparel, and generate a fresh stream of online revenue to support its rapidly growing digital business.

Check out the latest American Eagle Outfitters earnings call transcript.

But could it be a double-edged sword?

AEO's side bet on clothing rentals makes strategic sense, but it could also backfire if it takes off. The average U.S. adult between the ages of 25 and 34 spends an average of $161 per month on clothing according to Credit Donkey. Therefore, letting shoppers repeatedly rent out apparel for $50 month could cannibalize the company's sales. That probably won't hurt Aerie, since female shoppers probably won't rent intimate apparel, but it could cause problems for American Eagle, which generates much lower comps growth than Aerie.

It's too early to tell if American Eagle's rental experiment will pay off, but it could leverage its strong brand appeal to challenge Stitch Fix, Amazon, and other early movers across this nascent market.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.