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The Hidden Gem in Stitch Fix's Earnings Report

By John Ballard - Mar 16, 2021 at 9:11AM

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This subtle move by management could be a game-changer for future growth.

Nearly half of U.S. apparel spending is expected to shift online by 2025, according to research from Euromonitor International. Stitch Fix (SFIX 0.85%) is already seeing demand pick up with the number of first-time clients migrating to the platform at multiyear highs. To capture this tremendous growth opportunity, management is ramping up investment in inventory to keep up with the anticipated demand. 

One hidden gem in the recent earnings report was management's discussion of moving to a vendor-managed inventory model, which is used by some of the largest retail companies to operate their world-class supply chains. This could be an early indicator that Stitch Fix is about to see a significant acceleration in growth over the next few years.

Here's how this new inventory model could help Stitch Fix capture more market share and firm up its profitability.

Two women processing an order for clothing items.

Image source: Getty Images.

Accelerate growth

Stitch Fix has relied on selling merchandise through a wholesale model, but this has limited the breadth of the assortment. However, with active client growth starting to accelerate back to pre-pandemic levels, the company wants to expand the selection to satisfy new customers joining the platform. An expanded assortment will be important when the company launches the direct-buy service for all clients in the next year. 

With a vendor-managed system, the retailer shares its demand and inventory data with the supplier, which uses that data to replenish the company's inventory when it's running low. It basically puts inventory management on autopilot, leading to a faster supply chain and better availability for in-demand items. 

If Stitch Fix's assortment is too limited, customers will look elsewhere, and that's not what the company wants when it's trying to tackle an online apparel market worth $127 billion and growing. A vendor-managed model would help Stitch Fix have the right product at the right time during periods of demand spikes, which would have come in handy last year.

During the pandemic, customers were seeking more athleisure apparel and less formal clothing for the office, which left Stitch Fix shorthanded and likely contributed to lower revenue growth. 

President Elizabeth Spaulding laid out the potential benefits of this change on the recent call, "We believe moving to a multi-inventory model will enable us over time to meaningfully expand selection, allowing us to attract more clients, drive higher demand, and create a flywheel of accelerated growth." 

Improve profit margins

Effective inventory management is crucial to keep margins firm in a competitive retail industry, but it's a delicate balancing act. Too much inventory can lead to discounted merchandise and lower profitability, and this can get challenging when demand fluctuates wildly like it did last year.

During the worst of the pandemic, Stitch Fix's year-over-year revenue growth decelerated from 22% to 9% sequentially in the fiscal 2020 third quarter. Lower demand pressured the company's gross margin, and as a result, the company swung from a net profit of $11.3 million during the six-month period ending in Feb. 2020 to a net loss of $11.5 million over the most recent two quarters. 

A vendor-managed model would allow Stitch Fix to expand or shrink its inventory based on demand and reduce the risk of markdowns from carrying too much merchandise. This is particularly powerful in the hands of a tech-focused business like Stitch Fix, one whose entire business strategy relies on collecting data from customers about their likes and dislikes to deliver a personalized shopping experience. Applying its data-driven algorithms to an automated inventory system should prove very effective. 

Laying the groundwork for more growth

Despite the disappointing quarter, when revenue and adjusted revenue fell short of expectations due to COVID-related issues, the shift in the company's inventory strategy is a positive sign for the future. Management senses that the online apparel market is about to take off, and when it does, it should be well prepared to meet demand with a broad selection and fast restock times. 

Overall, these adjustments should translate to more satisfied customers, higher spending per client, and greater market share over time. As CEO Katrina Lake stated on the earnings call, "[W]e are continuing to see clients migrating to our offering at the highest rates we've seen in years, and we're excited about the opportunity to accelerate our share gains over time." 

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