Original release date April 29, 2024: Our analysts find
that despite the obvious differences between retail fashion and
airlines, struggling brands in both industries can use a similar
playbook for a turnaround.
----- Transcript -----
Ravi Shanker: Welcome to Thoughts on the
Market. I'm Ravi Shanker, Morgan Stanley's North American Freight
Transportation and Airlines Analyst.
Alex Straton: And I'm Alex Straton, Morgan
Stanley's North America Softlines, Retail and Brands Analyst.
Ravi Shanker: On this episode of the
podcast, we'll discuss some really surprising parallels between
fashion, retail, and airlines.
It's Monday, April 29th at 10am in New York.
Now, you're probably wondering why we're talking about airlines
and fashion retail in the same sentence. And that's because even
though they may seem worlds apart, they actually have a lot in
common. They're both highly cyclical industries driven by
consumer spending, inventory pressure, and brand attrition over
time.
And so, we would argue that what applies to one industry actually
has relevance to the other industry as well. So, Alex, you've
been observing some remarkable turnaround stories in your space
recently. Can you paint a picture of what some fashion retail
businesses have done to engineer a successful turnaround? Maybe
go over some of the fundamentals first?
Alex Straton: What I'll lead with here is
that in my North America apparel retail coverage, turnarounds are
incredibly hard to come by, to the point where I'd argue I'm
skeptical when any business tries to architect one. And part of
that difficulty directly pertains to your question, Ravi -- the
fundamental backdrop of the industry.
So, what are we working with here? Apparel is a low single digit
growing category here in North America, where the average
retailer operates at a mid single digit plus margin level. This
is super meager compared to other more profitable industries that
Ravi and I don't necessarily have the joy of covering. But part
of why my industry is characterized by such low operating
performance is the fact that there are incredibly low barriers to
entry in the space. And you can really see that in two dynamics.
The first being how fragmented the competitive landscape is. That
means that there are many players as opposed to consolidation
across a select few. Just think of how many options you have out
there as you shop for clothing and then how much that has changed
over time. And then second, and somewhat due to that
fragmentation, the category has historically been deflationary,
meaning prices have actually fallen over time as retailers
compete mostly on price to garner consumer attention and market
share.
So put differently, historically, retailers’ key tool for drawing
in the consumer and driving sales has been based on being price
competitive, often through promotions and discounting, which,
along with other structural headwinds, like declining mall
traffic, e-commerce growth and then rising wages, rent and
product input costs has actually meant the average retailers’
margin was in a steady and unfortunately structural decline prior
to the pandemic.
So, this reliance on promotions and discounting in tandem with
those other pressures I just mentioned, not only hurt many
retailers’ earnings power but in many cases also degraded
consumer brand perception, creating a super tough cycle to break
out of and thus turnarounds very tough to come by -- bringing it
full circle.
So, in a nutshell, what you should hear is apparel is a low
barrier to entry, fragmented market with subsequently thin
margins and little to no precedent for successful turnarounds.
That's not to say a retail turnaround isn't possible, though,
Ravi.
Ravi Shanker: Got it. So that's great
background. And you've identified some very specific key levers
that these fashion retail companies can pull in order to boost
their profitability. What are some of these levers?
Alex Straton: We do have a recent example
in the space of a company that was able to break free of that
rather vicious cycle I just went through, and it actually lifted
its sales growth and profitability levels above industry average.
From our standpoint, this super rare retail turnaround relied on
five key levers, and the first was targeting a different customer
demographic. Think going from a teens focused customer with
limited brand loyalty to an older, wealthier and less fickle
shopper; more reliable, but differently.
Second, you know, evolving the product assortment. So, think
mixing the assortment into higher priced, less seasonal items
that come with better margins. To bring this to life, imagine a
jeans and tees business widening its offering to include things
like tailored pants and dresses that are often higher margin.
Third, we saw that changing the pricing strategy was also key.
You can retrain or reposition a brand as not only higher priced
through the two levers I just mentioned, but also try and be less
promotional overall. This is arguably, from my experience, one of
the hardest things for a retailer to execute over time. So, this
is the thing I would typically, you know, red flag if you hear
it.
Fourth, and this is very, very key, reducing the store footprint,
re-examining your costs. So, as I mentioned in my coverage, cost
inflation across the P&L (profit and loss) historically,
consumers moving online over time, and what it means is retailers
are sitting on a cost base that might not necessarily be right
for the new demand or the new structure of the business. So,
finding cost savings on that front can really do wonders for the
margins.
Fifth, and I list this last because it's a little bit more of a
qualitative type of lever -- is that you can focus on digital.
That really matters in this modern era. What we saw was a
retailer use digital driven data to inform decision making across
the business, aligning consumer experience across channels and
doing this in a profitable way, which is no easy feat, to say the
least.
So, look, we identified five broad enablers of a turnaround. But
there were, of course, little changes along the way that were
also done.
Ravi Shanker: Right.
Alex Straton: So, Ravi, given what we've
discussed, how do you think this turnaround model from fashion
retail can apply to airlines?
Ravi Shanker: Look, I mean, as we
discussed, at the top here, we think there are significant
similarities between the world of fashion retail and airlines;
even though it may not seem obvious, at first glance. I mean,
they're both very consumer discretionary type, demand
environments. The vicious circle that you described, the price
deflation, the competition, the brand attrition, all of that
applies to retail and to airlines as well.
And so, I think when you look at the five enablers of the
turnaround or levers that you pull to make it happen, I think
those can apply from retail to airlines as well. For instance,
you target a different customer, one that likes to travel, one
that is a premium customer and, and wants to sit in the front of
the plane and spend more money.
Second, you have a different product out there. Kind of you make
your product better, and it's a better experience in the sky, and
you give the customer an opportunity to subscribe to credit cards
and loyalty program and have a full-service experience when they
travel.
Third, you change your distribution method. You kind of go more
digital, as you said. We don't have inventory here, so it'd be
more of -- you don't fly everywhere all the time and be
everything to everyone. You are a more focused airline and give
your customer a better experience. So, all of those things can
drive better outcomes and better financial performance, both in
the world of fashion retail as well as in the world of airlines.
Alex Straton: So, Ravi, we've definitely
identified some pretty startling similarities between fashion
retail and airlines. Definitely more so than I appreciated when
you called me a couple months ago to explore this topic. So, with
that in mind, what are some of the differences and challenges to
applying to airlines, a playbook taken from the world of fashion
retail?
Ravi Shanker: Right, so, look, I mean, they
are obviously very different industries, right? For instance,
clothing is a basic human staple; air travel and going on
vacations is not. It's a lot more discretionary. The industry is
a lot more consolidated in the airline space compared to the
world of retail. Air travel is also a lot more premium compared
to the entire retail industry. But when you look at premium
retail and what some of those brands have done where brands
really make a difference, the product really makes a difference.
I think there are a lot more similarities than differences
between those premium retail brands on the airline industry.
So, Alex, going back to you, given the success of the turnaround
model that you've discussed, do you think more retail businesses
will adopt it? And are there any risks if that becomes a norm?
Alex Straton: The reality is Ravi, I
breezed through those five key enablers in a super clear manner.
But, first, you know, the enablers of a turnaround in my view are
only super clear in hindsight. And then secondly, one thing I
want to just re-emphasize again is that a turnaround of the
nature I described isn't something that happens overnight.
Shifting something like your consumer base or changing investor
perception of discounting activity is a multi year, incredibly
difficult task; meaning turnarounds are also often multi year
affairs, if ever successful at all.
So, looking ahead, given how rare retail turnarounds have proven
to be historically, I think while many businesses in my coverage
area are super intrigued by some of this recent success; at the
same time, I think they're eyes wide open that it's much easier
said than done, with execution far from certain in any given
turnaround.
Ravi Shanker: Got it. I think the good news
from my perspective is that hindsight and time both the best
teachers, especially when put together. And so, I think the
learnings of some of the success stories in your sector can not
only be lessons for other companies in your space; they can also
be lessons in my space. And like I said, I think some airlines
have already started embarking on this turnaround, others are
looking to see what they can do here. And I'm sure again, best
practices and lessons can be shared from one sector to another.
So, Alex, thanks so much for taking the time to talk to us today.
Alex Straton: It was great to speak with
you, Ravi.
Ravi Shanker: And thanks for listening. If
you enjoy Thoughts on the Market, please leave us a review
wherever you listen to the show and share the podcast with a
friend or colleague today.
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