This last decade has been one of accelerated changes for the fashion industry. All of the value chain’s ladders have been affected and transformed by the impact of the international economic crisis, firstly, and by digitalisation and consumption habits, afterwards. If the fiscal years of 2010 and 2011 could be titled as the online fever ones, 2017 will be granted with the title Retail Apocalypse. 2018 will be recorded in history of fashion industry as the year in which the model wore out.
Fashion consumption is frozen (almost completely) all around the world, with a special emphasis around mature markets, those that provide fashion giants with a bigger share of their business. In parallel, fashion loses positions in the priorities of consumers and notices how other sectors are starting to steal its shares. In this environment, fashion is turning its distribution upside down looking for a new balance whilst its margins shrink and its old pricings do not fit anymore.
Throughout the last twelve months it is not hard to find examples of these symptoms of model exhaustion. It is precisely the global giants of the industry the ones that with case histories show a better picture of the situation. And the proof is in the pudding. In three of them, as follows.
Fashion consumption is frozen all around the world, with a special emphasis around mature markets
In August, Morgan Stanley dealt a hard blow to Inditex and, therefore, to the whole of the sector. And as the famous saying goes, thatch your roof before the rain begins. A few weeks before the presentation of half-year results, the United States investment bank reiterated its advice of purchasing Inditex securities as the Spanish group would soon experience a “gradual fall” and an “unavoidable reduction in the long term”. According to the investment bank, the Spanish multinational “is more sensitive to currencies by the day, has registered a decrease of its margins in the last five years and is facing the same pressures to change its channel as most of the other fashion retail groups”. What did Inditex do? React, but changing its model.
Shortly after the bomb dropped by Morgan Stanley, the company presided by Pablo Isla profited from the release of a store in Milan to announce that in 2020, it would sell online in all countries of the world. Beyond the exploding effect of the news, the announcement entailed that Inditex would stop being a retailer with online presence to become a pure player with stores. The same, but the other way around: shake the cocktail shaker of distribution in the search for a new formula.
More examples. Nothing more and nothing less than the second biggest fashion distributor. “Our evolution needs to be seen within the wide context of transformation that the industry is undergoing”. With this sentence, Karl-Johan Persson, H&M’s CEO, explained its results of fiscal 2017, presented at the beginning of 2018. The Swedish group is suffering more and for a longer time than Inditex, and the adjustment of its model has been made clear throughout 2018: besides reordering its network of stores, the group has directly chosen to close concepts. Cheap Monday, on one hand, and Nyden, on the other. The latter had been released thought as a pure player that would approach a new generation of consumers that seem unwilling to purchase clothing anymore.
Pricing, the Internet and the background are all pressuring the profitability of fashion, a sector that will have to work through progressively tighter margins
And a third example, the United States giant Sears. Last October, the department stores group filed for Chapter 11, but the truth is that it had been warning about it for some quarters at the time. It underwent personnel cuts and stores’ closure, and had been drowned by debt. Awaiting to clear out the future of the company (which now depends on a purchasing offer issued by its president), Sears is the biggest example of loss of importance in the department stores model, both by the weight of brick balance as by the progressive loss of purchasers who are seeking new formats. And all that considering that Sears could have had it all. Not in vain, it owned a very powerful tool, the catalogue, the most immediate predecessor of online sales.
Twelve key months
But, why now? Why has 2018 been the year in which fashion discovered that its grounds were no more useful? The answer, recession. Yes, the same that damaged the sector in 2008 after it burst in 2007 is the one to bring the fashion business down in the present.
Fashion, as a dispensable good, is always one of the first to suffer the crisis. That’s what happened, for instance, during 2008, with companies such as Tiffany forecasting in its results the economic hurricane that was going to take over the whole world. At the same time, when recovery comes, it is also fashion the one that profits first.
In August of 2017, the European Commission declared the end of the crisis in the Eurozone, ten years after such period started. Following that theory, fashion should have started to reap the fruits of the recovery, but the truth is that 2018 brought with it a harsh reality: recession was not to blame, at least not completely.
Since 2007, all companies no matter the model and the segment in which they operated, have blamed recession and the low degree of consumption of employment, closures and other adjustments’ regulations. However, the end of the crisis has laid bare that the situation was much more serious. An exogenous factor like the international economic crisis was covering an endogenous issue, a structural and model crisis that has to be solved urgently.
After 2013, half way through the last crisis, analysts and political journalists added to their dictionaries the word disaffection. This concept enabled to showcase the citizens’ disregard of traditional political parties and the sudden rise of alternative congregations and movements. Disaffection helped to define, with formal vocabulary, that the citizens do not give a damn about politics.
And if they do not care about politics, the feeling grows in regards fashion. It must be said, however, that the citizenship that generally disregards the sector is the one in developed countries. People have stopped to put clothes in their top priorities going for other expenses. Make a simple math: the annual expense of Netflix, HBO or Spotify is the same as that of one signature jersey. And that translates to one jersey less inside the wardrobe of consumers.
Mobile phones, restaurants and travels have taken over fashion in Spain as well as in other of the top countries for this sector. “As more consumers spend their money on experiences, their priorities shift” points out Euromonitor in reference to the United States. “In an environment of abundant low-cost and discounts, consumers have had enough and have started to adopt practical purchasing behaviours, reducing impulse purchases”, sustains the group when talking about France. One just needs to analyse how the weight of fashion in the shopping basket of families has evolved during recent years in order to notice fashion’s loss of positions in consumer preferences.
Categories such as travels, communications or restaurants gain weight in the purchasing balance at the same time as fashion loses it
According to data from the United States Government Bureau of Labor Statistics, the average expenses of homes in the country stood at 60,060 dollars per year in 2017, which is higher than the figure of 55,978 dollars from two years ago, in 2015. In a country where public health and education is quite limited, the expense in clothes ranks around the lowest priorities for expenses, with 3.05% of the total in 2015. But not just that, the disbursement of Americans has reduced 3.29% in just two years.
In the European Union, families destine 4.9% of their total expense to the purchase of clothes and footwear, standing as the sixth most important category in base to budget expenditure. The weight of fashion in domestic disbursement is higher to that of other matters such as transport (2.8%), communications (2.5%) and alcoholic drinks and tobacco (3.9%), although they are all way behind household, food or restaurants and coffee shops’ costs.
Furthermore, the share stands at exactly the same figure as in 2014, the first year with available data gathered by Eurostat. That means that, although consumption has recovered, the average expense of fashion has not increased.
Mature markets go downwards
In the United States and Europe, the two biggest markets for the fashion industry (China threatening to take the United States’ crown), disaffection is already entailing a reduction of the sector’s volume of business, which ultimately implies a freeze of the world’s consumption of clothes, footwear and complements. Global fashion sales continue to grow, but their rate has slowed down noticeably in recent fiscal years. In 2017, the world’s fashion business ascended to 1.7 billion dollars, which represented an increase of 4% in base to last year.
Only Inditex has managed to scape the fall of the margin during one quarter, avoiding to participate in discounts and promotions
It has to be taken into account, however, that in 2016 the sector had grown by 3.8% registering its lowest rise since 2008, during full international crisis, as explained by Euromonitor. Brexit, Donald Trump in the White House, the escalation of terrorism around Europe or the Chinese economic deceleration all made the feeling of uncertainty grow in 2016, causing an impact in the world's economy. In 2017, the situation was quite similar and in 2018, the background has repeated itself, this time with crisis of migrations through the sea (in Europe) and through the land (in the frontier between Mexico and the United States) or even the trade war between Donald Trump and Xi Jimping.
“The era of robust growth following the recession could be over as we enter a period of continued uncertainty”, said Euromonitor at the end of fiscal 2016. The word uncertainty sneaked into the vocabulary of all companies, even those in the fashion sector (according to the report Global Fashion Drivers, more than half of the top one hundred companies in the sector mentioned it in their results of 2017), and that considering that the worst predictions have not been accomplished. Trump has not been as tough as expected and Brexit has not fully taken place yet.
Ahead of knowing the results for fiscal 2018, everything seems to point out that the trend of contention in the world’s consumption of fashion will be maintained. Despite the fact that growth in 2017 is quite superior to its precedent, it still stands below the figure registered in 2015, for instance, when fashion sales raised by 4.5%. Euromonitor’s predictions claim that the fashion business will grow only an interannual 2% until 2022.
Furthermore, the global growth of fashion industry must be directly attributed to the peak of developing markets, as in mature ones, the consumption of fashion is either falling or frozen. In the United States, fashion and footwear sales reduced both in value as in volume during 2017, according to Euromonitor, whereas in Germany, the market “was stranded despite favourable economic conditions”. In France, for its part, clothes and footwear sales decreased in value, and estimations point out that the trend will still follow this downward trend during the next years. In Italy, the business was kept “static” in volume, but decreased in value.
Whilst the predictions for future fiscal years in the main markets of the world for fashion sales are still going downwards, there are a few territories that stay above. The Middle East is another of the markets that has grown strongly during recent years, but the rate will decrease all through the end of the decade, according to predictions from Datamonitor and EAE Business School.
China, for its part, is still installed in a stage of growth, but its evolution is not the same as a decade ago. In the Middle East, growth continues to stand out, but civilian and political issues could become a risk in future years.
Latin America is, currently, the market with best predictions in the whole of the globe, although uncertainty also reigns over the land with problematic changes of governments in markets such as Colombia or Mexico. According to data from the consultant BMI, Latin America is the biggest growing market for the fashion industry all around the world, with a business of 160 billion dollars in 2016, a size much smaller than Asia but bigger than the Middle East. Predictions contemplate that the fashion industry will grow an annual 7.2% in Latin America all through 2021, when it Will surpass the 220 billion dollars.
Categories and margins
Not just the markets that traditionally have pulled the strings of fashion business are becoming exhausted, categories are doing the same too.
Women have historically been the subsector that provided the most sales to the whole of the fashion business. However, according to Euromonitor, during the last years it has been one of the categories with a lesser growth, which impacts automatically the whole of the sector’s business.
In the opposite side, there are two smaller categories as are childrenwear and menswear, which are beginning to grow at rates superior to that of women’s: they grow more but provide less to the conjunct of the business.
And lastly, the star category of the last years: the so-called athleisure as main protagonist. In any case, some reports claiming that there is a minor stagnation involving the sector are starting to come up, specially in the United States, where denim is going up instead. And if the fashion category that has grown the most in the world’s fashion industry slams on the brakes, what will happen with global sales?
With a shrinking market and, specially, with a crisis scratching the pockets of consumers, price has become a key element to compete in the fashion business. Price war has had several effects in the sector. The first is the peak of players such as Primark, whose main differentiation is price, and who have taken over the lower part of the pyramid. The second has been the loss of value in fashion and the rupture of consumers’ mental prices: how much do a pair of jeans cost nowadays? The third is, necessarily, the impact on the margins.
The numbers of companies do not work out, not even for the giants. International fashion groups are facing a reduction of their margins for some quarters now. Since 2011, Inditex has reduced its gross margin year after year: if in 2011 it stood at 59.3%, in 2014 it descended to 58.3%, and in 2015 it stood at 57.8%; in 2017, the ratio weakened again, standing at 56.3% compared to the 57% of the previous year. In the case of H&M, the gross margin has gone from 60.1% in 2011 to 54% in 2017.
However, Gap, immersed in a restructuration plan to reduce costs, has raised it: from 36.2% in 2011 to 38.26% in 2017. During the third quarter of 2017, however, Inditex has managed to revert this trend with a gross margin that ranks above 60%, its biggest one since 2014. How has it done such thing? Running away from the promotional policies that flood over fashion and which most players have not dared to scape yet.
Subscriptions to platforms such as Netflix, HBO or Spotify have become a mandatory expense for families
And there is one more element pressuring the margins: the Internet. In fact, that is one of the weakest points for the sector, according to analysts. The business experts insist that the unitarian margin of online sales is usually inferior to that of physical sales, although giants such as Inditex claim that it is not true and assure that the impact is not dilutive.
Be it as it may, the peak of the Internet is having a direct impact on the fashion business, specially in those players who based most of their activity on the brick, like department stores or distribution giants. Nowadays, around 20% of fashion purchases are done online, a percentage that will grow to 25% in 2020, according to data from BCG. This evolution is causing an unavoidable adaptation of distribution networks that have to be less dependent on physical retail by the day.
Volumen and pyramid
In that context, volume has become a key element to compete. M&As have accelerated during recent fiscal years, specially in sectors such as cosmetics and luxury, although they are also reaching large distribution. It is not about being the biggest, but about having enough volume so as to compete in such a complex environment as the present one.
International consultant McKinsey analysed the relationship between the fashion companies’ sizes and their production of profits. One of the conclusions extracted from the research was that 20% of the sector’s players created 100% of their total profit during the last decade. Another 20%, however, either disappeared or reduced its size. However, for McKinsey, the “losers” are medium companies that have not been able to face the complex environment of the last fiscal years.
Medium sized companies were situated, traditionally, in the middle part of the fashion pyramid, understanding that in the top, there is the most extreme luxury, and in the bottom, large distribution, represented by Zara or H&M. However, the pyramid has changed: Primark occupied the lower part and forced Zara to rise and become owner and lord of the medium range. All those medium brands that have not managed to jump up and sneak into the higher parts of the pyramid will have a hard time surviving.
But the truth is that, whether it’s in volume, the Internet, medium ranges or high ones, consumers must really be in the middle. If fashion aspires to seduce consumers back, it is necessary to give a Lacoste jersey its lost value so that it can battle against a year of Netlfix subscription.