Lululemon Athletica (NASDAQ:LULU) knocked it out of the park in 2018, with balanced growth across its various categories, geographies, and digital channels. Management sees the momentum in these areas continuing into 2019 and beyond.
With a tailwind at its back, the company wants to leverage the strength of its brand to expand into additional product categories. Lululemon has been testing skincare products, which it plans to roll out soon, but during a recent investor presentation in April, management announced they had discovered an opportunity to offer something unique in footwear.
Making shoes is an entirely different venture from making yoga pants, which should have investors wondering: Is Lululemon venturing too far away from its core competencies?
Footwear is a lower margin business
To make footwear, Lululemon must create a supply chain to accommodate all the materials that go into making shoes, including nylon, leather, plastic, and rubber. Combined with industry competition, shoes tend to earn lower margins compared to apparel.
For example, Nike has a 44% gross margin, with two-thirds of its top line generated by footwear. By comparison, Lululemon earns a gross margin of 55%, which leaves its operating margin at an industry-leading 21%.
Some analysts are concerned about Lululemon butting heads with industry giants Nike and Adidas. However, I don't believe competition is as significant an obstacle for a rising brand like Lululemon.
As strong as Nike is at footwear, it doesn't have total dominion over the market. For one, the swoosh brand has been vulnerable to competition from Adidas and smaller footwear upstarts in recent years. The success of Allbirds shows us there's demand for alternatives to the big sneaker companies.
Also, Nike's double-digit growth in apparel indicates consumers are willing to shop one brand for both footwear and clothing. This may work in favor of Lululemon, given the incredible brand loyalty of its customer base.
Lululemon knows what its customers like ...
Keep in mind, Lululemon isn't going after footwear with cold feet. Its partnership with Athletic Propulsion Labs has given management some insights into what its customers are looking for in a workout shoe. Lululemon believes it can leverage its successful design approach to clothing for shoes as well.
During a recent investor presentation, Lululemon's head of product design, Sun Choe, explained how the company plans to use its "science of feel" method to expand into additional product categories:
We feel really confident that, with the successes we've had using science of feel as our innovation platform, it is not only a differentiator, but we know that it is commercially very viable. And so, we're really excited to be able to continue using this and leveraging this philosophy into all of our products in the years to come.
To understand what Choe means by the "science of feel," she discussed how the company's popular Nulu fabric came about.
Nulu was a result of observing customer behavior. Management noticed that customers were often sizing up or sizing down when buying an item. This behavior told management customers were looking for a certain feel, such as a compression fit or a loose fit, they weren't getting with Lululemon's assortment. As a result, the design team developed a new fabric that provided a barely there feel (Nulu), and it's been very successful in driving sales.
Its management's ability to act on these kinds of insights into consumer preferences that makes me confident that Lululemon will be successful in footwear.
However, Lulu-branded footwear likely won't show up anytime soon. One analyst believes it will take at least two years, given the company has historically taken a slow, methodical approach to pursuing new opportunities.
... and it doesn't want to sell itself short
New CEO Calvin McDonald sees a long runway of growth for the brand. The size of the global sportswear market is estimated at $115 billion, which is Lululemon's current market opportunity if they stick with apparel. Adding adjacent product categories like skincare and footwear expands the addressable market to six times the current size, or more than $600 billion.
The concern about lower margins from selling footwear pales in comparison to that enormous opportunity. With the tremendous growth Lululemon is experiencing right now, the company would be severely limiting its potential to say "no" to footwear.
The ultimate challenge will be making a footwear product that is differentiated from anything else on the market. With Lululemon's unique approach to design that has already paved the way for success in apparel, I believe the company is up to the challenge.