Fashion Risk

Fashion is risky business. Who knows what works? In the investment circles, buying stocks or bonds of a company that sells modish products is referred to as taking on "fashion risk". Rightfully so, because many of them fail, with the most recent example being Coldwater Creek. In this post, I will use Coldwater Creek as a case study for some of the possible pitfalls for an apparel retailer and discuss strategies for convalescence.

Coldwater Creek, a specialty clothing retailer, filed for bankruptcy on April 11. According to the recent liquidation plan, all term loan, priority and secured claims will be paid in full. Unsecured claims would recover an estimated 4.43%. TheDeal.com

The retailer was once beloved by middle-class, professional women for its effortlessly chic styles. It started as a catalog company back in the 80s and soon began opening retail stores in the 90's.

"The shopping centers, located in upper-middle-class neighborhoods, cater to the company's core audience: women who earn an average of $70,000 a year and who are drawn to such Coldwater Creek staples as $79 burnished silk jackets and $65 reversible suede belts... 

(Dennis) Pence is rushing to capitalize on an emerging demographic group that retail experts have dubbed the zoomers. They are baby boomers with a zest for living" Bloomberg BusinessWeek

Fast forward to April 2014 and the Company filed for bankruptcy after attempts by the debtors to refinance the debt, recapitalize the balance sheet and even sell the enterprise outright failed. What happened?

2008 happened, and everything went downhill from there. Net sales declined approximately 32% from its peak in 2006 to $742 million in 2013. The Company has cited everything from a slow-down in traffic to merchandising issues for the steep decline in same store sales. Following the reduced revenues, the buildup in inventory and its subsequent markdowns resulted in a deterioration of margins.

James A. Bell, EVP, COO and CFO of Coldwater, stated in the Declaration in Support of First Day Motion:

"From 2011 to 2013, the Debtors attempted a targeted turnaround process, which focused on the following:  a) incorporating cross-channel discipline into product and creative functions b) establishing the foundation of product assortment architecture c) acquiring retail-centric talent d) developing and implementing a real-estate optimization program e) positioning the brand strategy to ensure focus on target customer and f) re-engineering design and product development functions." Pacer

In order to gauge what the problems could have been, I did a little digging online for reviews from customers and employees. Here are some quotes that sum up many of the issues.

"Coldwater Creek USED to be a place women could go to find elegant, classic fashions. This year (2013) in particular, they have seemed to slide down that same slippery road as JC Penneys and KMart, which has resulted in imported, tacky, frumpy-looking clothing." Customer, May 2013

"I hear CWC is trying to grow back its customer base, but I just took a look at their website. Styles are dowdy and colors are drab. With my past experience with CWC poor quality and fit, there is nothing that tempts me to try again." Customer, October 2013

"Return policy is too liberal. End the 'anything, anytime, for any reason' deal." Employee, November 2011

"People bring stuff back from 5 years ago and get money or a gift card." Employee, December 2011

"While the employee discounts are good, the quality of the products have dramatically declined over the past 3-5 years." Employee, August 2012

"They are trying to change their entire customer base and it makes it difficult for the store emplyees to help the customers that made the company so popular to begin with. Not every customer wants short sleeve tops, slim leg jeans, and shapeless tees. Bring petites back to the stores we are losing customers everyday because we are only carrying pants in the store. Same with 3X sizes for customers." Employee, August 2012

A few observations:

1.  Returns Policy- I wouldn't recommend any turnaround strategies without a through quantitative analysis of costs and benefits. That said, anecdotal information could point to where corrective actions may be necessary. Depending on the negative contribution margin due to returns, the policy may be significantly hurting profitability OR it may just be a perk that doesn't make a significant difference in the bottom line. It would be helpful to do a margin impact (since nonperforming inventory is liquidated to offset some of the cost) curve based on the difference between time of sale and time of return to see if the returns are a significant hit to profitability. 

2.  Fast Fashion- In the mid 2000's with increased globalization and textile outsourcing, the fashion game changed. Zara is often noted as the pioneer of "fast fashion", an idea that fashion should be as responsive as it is innovative. Unlike traditional fashion labels that produced two main collections a year, fast fashion concepts such as Zara, H&M and Topshop design, manufacture and deliver many collections over the year to drive traffic. The two main determinants of fast fashion are short production and lead times and highly fashionable product design. Here's more from a Wharton paper:

"Short lead times are enabled through a combination of localized production, sophisticated information systems that facilitate frequent inventory monitoring and replenishment and expedited distribution methods. 

The second component (trendy product design, Enhanced Design) is made possible by carefully monitoring consumer and industry tastes for unexpected fads and reducing design leadtimes. Benetton, for example, employs a network of "trend spotters" and designers throughout Europe and Asia, and also pays close attention to seasonal fashion shows in Europe." Cachon and Swinney, "The Value of Fast Fashion".

The benefits of quick response strategies influence consumer behavior by reducing the frequency and severity of season-ending clearances. Enhanced design capabilities result in products that are of greater value to the customer in the present time and exploit this greater willingness-to-pay by charging higher prices on trendier pieces than on basics.

In contrast to the fast fashion front-runners, Coldwater Creek explains its merchandising process in the 'Risks' section of its 10-K:

"On average, we begin the design process for apparel nine to ten months before merchandise is available to consumers, and we typically begin to make purchase commitments four to eight months in advance. These lead times make it difficult for us to respond quickly to changes in demand for our products...

Our inventory levels and merchandise assortments fluctuate seasonally, and at certain times of the year, such as during the holiday season, we maintain higher inventory levels and are particularly susceptible to risks related to demand for our merchandise. If the demand for our merchandise were to be lower than expected, causing us to hold excess inventory, we could be forced to further discount merchandise, which reduces our gross margins and negatively impacts results of operations and operating cash flows." 

Coldwater Creek 10-K. 

Essentially, the Company is making bets about what will work in fashion 4-8 months in advance. For equity holders, that is like investing in a company that buys forward contracts based on fashion trends!

I am not suggesting that an apparel designer and retailer aimed at women in their 30's to 50's ought to carry pieces trendy enough for teenagers, but it does help to be more nimble when it comes to responding to consumer demand. And in order to be more reactive to consumer demand, faster lead-times are essential.

Of course, there is a trade-off: faster lead-times and enhanced design require giving up a lot of design control and following trends in an efficient way. For example, Zara's designers work to imitate fashion, rather than innovate fashion. Only the fabrics are ordered before the season starts due to long lead times, but even those are ordered uncolored so there is flexibility on changing them right before the order. Suppliers have more autonomy in design, so they become more of strategic partners rather than just an operational necessity. Zhelyazkov, "Agile Supply Chain". 

3. Technology- As a retail grows into servicing customers through multiple channels, it's IT system becomes incredibly important. Macy's merchandising initiatives called My Macy's and Omni-Channel were initiated in 2009 as a way to delight customers at a local level and provide a a seamless shopping experience regardless of the channel. Of course, this required significant IT capacity. 

"A single platform or visual merchandising software enables retailers to also extend the reach and relationship with their product suppliers, giving them insight into the merchandising process and ensuring they are able to act more quickly and sharpen their merchandising execution."  Retail Customer Experience

"Most retailers cannot match Macy's spectrum of Omni-Channel initiatives because they have not created the multi-year master plan needed to achieve it. Many retailers have not allotted the investment required to create accurate, real-time views of inventory, order management, supply chain." Seeking Alpha

Migrating everything over to a single ERP platform from various databases can be very costly and operationally awful; just ask Levi Strauss about its SAP disaster! In addition to an ROI analysis, it would be useful to examine scenarios where such a migration could go wrong and assess the possible impact of the worst case scenario before deciding on a solution. 

Lastly, an important public service announcement: Many firms lose touch with employees on the field and their customers as they grow. It should go without saying that employees in the front lines should be empowered to voice their concerns, those opinions should be an important part decision making process, and the reasoning behind those decisions should be freely shared with the employees. "Store employees can in turn provide faster feedback when a campaign has been executed so corporate has a clear understanding of compliance, the impact an accurately executed campaign has on sales and the customer feedback from that geographic market," Retail Customer Experience. Open communication within a company goes a long way and could make the difference between success and failure.