Leave me a note, and I will get back to you. 


Ottawa, ON
Canada

613 868 3950

The Canadian Financial Advisor

What Happened to lululemon athletica?

Benjamin Felix

I don't pick stocks.  I don't really think that anyone can pick stocks.  A lot of analysis can be done to try and forecast stock prices, but it will never be possible to predict all new information (weather, wars, celebrities' actions...all new information).  Nobel Prize winner Gene Fama believes that all available information is reflected in the price of a security.  If we cannot predict all new information, and all new information is factored into the price of a security it is safe to say that success in forecasting will be as random as the development of new information. 

As much as I disagree with the fundamental concept of picking stocks, I do enjoy a good business case.  If I took one single thing away from my MBA (other than the people I met) it is that companies fail when they get away from their core competencies.  In attempts to keep pace with their past growth rates, poorly managed companies tend to stray from the strategy that brought them success in the first place.  I think that over the last few years lululemon has departed from their core strategy.  It is no surprise to me that they are faltering; the original shareholders cashed out, but is that the path to building long-term value?  Is it strategic for a company to create strong core competencies and maintain them just long enough for the original shareholders to cash out in the primary market only to leave the company to be ravaged by the demands of the secondary market?  Studies have been conducted on the willingness of executives to destroy long-term shareholder value in order to achieve short-term financial goals, and I think this is exactly what has happened at lululemon.  I don't blame them.  Chip Wilson is a business man.  Christine Day had analyst expectations to meet.

Dollar signs and ratios overcame the company's original vision; quality was traded for quantity and they began to diversify away from their core products.  I'd like to walk through how the industry environment has changed since the company began.

lululemon currently has multiple suppliers in a handful of developing countries; a far cry from back in 2004 when they first began outsourcing and had one single supplier in China which was merely a foreign extension of the original Vancouver manufacturer.  In 2004, the supplier had a significant amount of power over the price that they charged for the premium, exclusive, luon blend of 85% Nylon and 15% Lycra that Chip Wilson had created.  lululemon and their supplier had a mutually beneficial partnership that allowed both of them to become highly successful while creating high quality products.  It should not come as a surprise that as the company grew, margins and scale needed to increase and more suppliers were employed.  With the current number of suppliers that lululemon has, and the fact that luon can be easily replicated by other manufacturers, suppliers have been rendered powerless.

The power of buyers is also a far cry from 15 years ago when the company had just begun and the product was sought after as a status symbol and a fashion statement; women would pay $100 for a pair of Groove Pants without thinking twice, they were powerless against the draw of the brand.  As lululemon became obviously successful, multinational, diversified athletic apparel companies started manufacturing yoga equipment to keep pace with the developing market.  While this was happening, yoga went from being a craze, to a trend, to a mainstream form of exercise.  In the current market, yoga apparel is everywhere and buyers have a huge amount of power over the decision of where to buy.  Due to these developments, the market has become more price sensitive, and it is exceedingly difficult for lululemon to justify selling pants at a premium price point when their quality is no longer a differentiating factor.

Competition in the athletic apparel industry is extremely high.  The industry is fragmented and consists of both small private manufacturers like One Tooth, and huge companies like Nike, Adidas, and Roots.   In their 2013 10-K, lululemon acknowledges that the competitive landscape is not easy to operate in.  They actually explain the competitive rivalry in their industry much better than I can (I have paraphrased):

"We also face competition from wholesalers and direct retailers of traditional commodity athletic apparel, such as cotton T-shirts and sweatshirts. Many of our competitors are large apparel and sporting goods companies with strong worldwide brand recognition, such as Nike, Inc., adidas AG, which includes the adidas and Reebok brands, and The Gap, Inc, which includes the Athleta brand. Because of the fragmented nature of the industry, we also compete with other apparel sellers, including those specializing in yoga apparel. Many of our competitors have significant competitive advantages, including longer operating histories, larger and broader customer bases, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, store development, marketing, distribution and other resources than we do. In addition, our technical athletic apparel is sold at a price premium to traditional athletic apparel.

Our competitors may be able to achieve and maintain brand awareness and market share more quickly and effectively than we can. In contrast to our “grassroots” marketing approach, many of our competitors promote their brands through traditional forms of advertising, such as print media and television commercials, and through celebrity endorsements, and have substantial resources to devote to such efforts. 

In addition, because we own no patents or exclusive intellectual property rights in the technology, fabrics or processes underlying our products, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrication techniques and styling similar to our products."

If consumers choose not to buy yoga (or run, or dance) clothing at all, there are substitutes.  lululemon is much more than athletic clothing, it is casual wear and fashion; I think that from a strategic standpoint buying jeans or cotton sweatpants instead of lululemon clothing can be a logical substitute.  lululemon clothing has not fully lost its appeal as athletic apparel, but the brand had evolved into something not just sought after for use at the yoga studio or gym.  This clothing was trendy; it was fashionable and normal to wear the stretchy yoga pants out in public as if they were jeans.  Maybe I'm getting older and am not with the times any more, or maybe it's because it's winter, but it seems to me that wearing yoga pants is far less socially acceptable than it was a year ago.  The next time Ocean and Duke have a few bills to blow on clothes, it's my bet that they're looking for something that they can wear in public without looking like they just came from the gym... I remember when tear-away track pants were cool too.

For new competitors to appear, the cost of establishing production facilities would be a hurdle, but so many of the new entrants are existing companies that are diversifying into lululemon's market.  Smaller companies are also able to enter into the market to mop up the segment that wants Canadian made, high quality clothing for use in a yoga class; I think this is a segment that lulu left behind when they began their multinational outsourcing and reduced their quality standards.  New entrants can come from both huge companies that are diversifying, and also small players that cater to the traditional yogi market.

So, lululemon is in a market where suppliers are commodities, buyers have tremendous amounts of choice, competition is cumbersome, their product is becoming less fashionable, and new players can easily enter the market; how did they become so successful in the first place?  They leveraged their core competencies.  An extremely high quality product, and an extremely loyal, culture driven, cult-like customer base.   We all know what happens when you bite the hand that feeds you.  When the "scarcity model" shifted to mass production outsourced to inexpensive manufacturers in India, China, and Vietnam, the cult-like following that had previously felt so privileged to own one of the limited items produced in a particular style and colour started to feel just like everyone else on the street.  As the products became less and less exclusive, they also became lower in quality; it's a lot harder to justify buying a pair of stretchy pants for $100 when it may only last a season and everyone else at the gym has the same pair.  In the beginning, the design was meticulously functional and created with material that was carefully monitored for quality.  More recently, we have seen disastrous items like this:

Jacket.jpg

and had serious problems with the quality of the material.  Now that their loyal customers have been insulted with over-priced, unfashionable, poor quality garments it is no surprise that many of the women (and men) that once praised the company are becoming less interested in the culture, and the products.  With the entrance of a new CEO, lululemon could still change its direction and improve its image, but it will never go back to being the glowing superstar of the retail world that it once was, and the image of the wealthy, sporty, yogi, wearing her Astro Pants to yoga class before going straight to the organic market to pick up wheat grass and lentils is dead.  If it's not dead, it's at least out of style.  People will still buy lululemon clothing, it is still functional, and I'm sure the quality will improve to match the price point, but they had something very special that was thrown to the wayside in order to drive profits.  The way that this company fell from grace is attributable to the pressures that the financial markets put on short term performance rather than accepting periods of under performance in light of building out a long-term strategy.  All of this is interesting, and managers can learn from it, but for investors none of it matters.  The market has already priced in everything that I have discussed.