Apparel III: Apparel Manufacturers and Fashion
A deep dive into the world of apparel brands and a cultural framework to analyze their intangible assets.
This is part Part III of my Apparel Series, a deep dive into the global apparel manufacturers and retailers industries that will help you find investment opportunities among these public companies.
In Part I, I reviewed the sector’s general competitive arena and explained why I believe it has potential as a source of investment ideas. Part II was dedicated to retailers, which concentrate on selling and the store.
In Part III, we will review the world of fashion, design, trends, and styles of apparel manufacturers. The topics covered are
Apparel’s intangible charm: how apparel brands compete on intangible investment and creativity, and how to evaluate them.
The world of apparel retailers is very tangible. We are concerned with operational efficiency, large structures, macroeconomic cyclicality, and operational leverage. In contrast, the world of apparel manufacturers (apparel designers or brands, in my terminology) is much more intangible. Analyzing intangible assets requires moving outside of the world of financial statements and into more qualitative clues. I propose a framework for analyzing those investments in intangibles like designers, collections and photo shoots.Main price and operational segmentations: a broad classification of the apparel universe. The world of apparel is so fragmented that Apparel IV will include a detailed subsegment description with examples.
Risks of fashion brands: fashion cycle risk, TAM limits, and downstream difficulties.
Apparel brands can ride the waves of fashion but can also drown in them. For the investor, the growing brand is specially risky because its growth looks sustainable when it is not. Here we analyze what can limit an apparel brand’s growth.
This article will give us the tools to evaluate whether apparel brands are doing what’s needed to succeed or if they are not performing and will suffer. Apparel IV, to be published in mid-May, will apply these concepts to more than 20 companies. Be sure to subscribe to receive it!
Note: Throughout the article, I will refer to apparel designers or brands, generally called apparel manufacturers. Most companies in apparel manufacturing don’t manufacture their products, so the name is confusing. They all design and nurture a brand, so I prefer the apparel designer/brand terminology.
1. Apparel and culture
Apparel is one of the most potent cultural objects.
Consciously or not, the apparel buyer is choosing messages/statements.
The first step in evaluating an apparel brand is to understand why people buy apparel in the first place. In short, people buy apparel to convey a message to their social peers. That message concerns the wearer’s position in society, not only top-down or rich-poor but also in many cultural subjects (conservativeness vs non-conformism, gender roles, rural vs. urban, ethnicity, etc.).
Apparel intersects all social interactions and is extremely potent as a symbolic object. In fact, when we think of cultural objects, apparel might be the most important one. Everyone wears apparel, and everyone has a (conscious or not) idea of what different types of apparel say about the wearer. Every person we have seen was dressed, and that information has slowly built up in our minds, connecting what they wore to who they were. In fact, our mind connected that piece of apparel to that person, their profession, their social status, where they were, what they ate, what car they drove, etc.
This is true for all apparel consumers, from the fashion victim spending $5 thousand on a purse to the value buyer purchasing a private label product at the lowest price possible in Walmart or Temu. The biggest difference between customer segments is in their level of awareness of the cultural message of different apparel pieces.
Cultural relevance and intelligence
A brand’s role is to provide cultural messages through their products that are meaningful for their target customers. This is called the brand’s cultural relevance
As explained in Apparel Part I, the mental role of the brand is to reduce the cognitive load of thinking about apparel and its cultural and material characteristics. People will associate a brand and its apparel with specific cultural messages. Brand A tells me, ‘Conservative, young, well-to-do, successful, masculine man,’ whereas Brand B tells me, ‘Rocker, young, well-to-do, happy, free, gender-neutral man.’
These interpretations are internal and affected by perception. Where I see a brand of rich people, someone else might see a brand of new-rich, or wannabes. Brands cannot control what happens in their customers' minds, but they can affect it through their communication. Therefore, when analyzing an apparel brand from the perspective of demand, we need to dissect what type of message is being transmitted and whether or not that message is relevant to the target customer. Thomai Serdari, consultant and professor at NYU, calls that message the brand’s cultural relevance and provides a framework for analyzing it based on fourteen dimensions, including ideology and purpose, time and space, body and social norms, social networks, brand spaces, and general knowledge.
The dimensions chosen by Serdari are just one possible framework. What matters is that we try to relate the elements that constitute an apparel brand to other cultural references relevant to the customers' minds. In fact, according to Serdari, this capacity to understand what people from another culture or social strata perceive from a brand is called 'cultural intelligence.’
As an example, we can analyze the current vogue of gorpcore (the use of heavy technical performance apparel like Canada Goose’s parkas as regular urban apparel), using Serdari’s framework:
Ideology and purpose: gorpcore transmits the idea that functionality is above form. The person wearing a Patagonia vest is wearing performance, technicality, science, and nature instead of formality, stiffness, and urbanity.
Creativity depends on the specific brand. Some brands, like Patagonia or Columbia, are so extended that using their products is no longer a creative or non-conformist statement. However, using a parka from Canada Goose or Moncler expresses a creative, out-of-the-ordinary desire.
Social norms and body perception: because gorp-core tends to hide the body and use square or boxy forms, it transmits a more conservative message, with prioritization of personal space and the rejection of the body as a part of the public sphere.
Social network: the extended use of Patagonia vests among finance-bros is a good example of how the specific network shapes the rest of the dimensions. This group was used to very formal attire and the vest could be read as an approximation to the more down-to-earth, no-nonsense format of Silicon Valley techies.
Even though we could debate at length whether my appreciation is correct, the important point is that we need to consider what the brand and the pieces transmit to the people buying them and their circles.
Investment in intangibles, the core company competency of the apparel brand
Building cultural relevance requires heavy investment in intangibles.
Managing that investment is the core competency of the apparel brand.
When we talk of cultural messages and relevance as being the core competitive arena of apparel brands, we are necessarily talking of intangibles. In fact, managing the cultural message operationally means managing investment in intangible assets.
Apparel brands need to invest in creative directors, creative teams, designers, fashion shows, influencers, celebrities, media content, and social media. This takes a lot of money and is generally not maintained as an asset on the balance sheet, or not even disclosed as separate items on the income statement. Companies put all of their apparel design costs as items buried inside CoGS or SG&A. The most we can generally know is how much was spent on advertising and marketing, but this generally refers more to bottom of the funnel activities (performance digital marketing, catalogs) than to top of the funnel activities (collection photo campaigns, fashion shows, engaging celebrities).
This is why the cultural framework is so important for analyzing apparel brands. We need to go outside of the financial statements into the Instagram page, the Vogue and Business of Fashion articles, the YouTube fashion influencer comments, and read the media section of the brand to find out about their campaigns.
It is a very subjective arena in which cultural intelligence is needed. We have to judge what is the cultural message behind using Celebrity A vs. B as a brand ambassador or making a collection photo shoot on a Caribbean beach vs. New York’s Time Square.
Practical analysis of intangible investments: the collage
Just like the designer in the studio makes a collage to represent her inspiration sources, I create a collage of pictures and phrases to represent what I believe is the company’s cultural assets and intangibles strategy.
When evaluating a fashion brand’s intangibles, my goal is to make a collage of pictures, frames from videos, and phrases from customers, managers, and critics. This will ‘paint’ an idea of the investments, the cultural references these investments relate to, and the effect on customers. This is a very subjective process, trying to tie financial performance to cultural performance. The main signs I’m looking for are consistency, innovation, boldness, and impetus. I get worried if the brand is just not doing much or the efforts are inconsistent.
The first step is to define the customer target and the brand’s vision. Sometimes, companies already present this information in their annual reports or earnings calls. If they don’t, it’s usually a bad sign, but we can still look for that vision ourselves. I want to summarize the vision in simple words like ‘nature, techy, urban, sophisticated,’ etc.
Then, I review the company’s earnings calls and blog or press releases for announcements of new products, collections, collaborations, ambassadors, and media campaigns. If an apparel brand does not mention these activities, it probably does not prioritize investment in intangibles, and most of its marketing expenditure goes to performance, bottom-of-funnel marketing, another bad sign.
Then, I look outside: articles in specialized magazines like Vogue or BoF, interviews with the creative directors or creative team members, YouTube hauls, and comments from fashion bloggers. Some well-known brands will also have collection books like those from Rizzoli International, which are very illustrative.
From everything I write down queues and comments on the style, the customer targets, and how their cultural needs are addressed. I look for images of the products and campaigns on Google and paste them into my document chronologically, mixed with comments on financial performance.
After this, I will have a map showing the relationship between the brand’s creative decisions (or lack thereof) and financial performance.
Mind the halo effect
Apparel brands create beautiful products and media. The investor should be wary of the mesmerizing effect of apparel and concentrate on the message/customer fit (cultural relevance).
The halo effect is a cognitive bias by which we attribute positive properties in one arena to people, companies, or objects that have positive properties in another arena, beauty or past success being at the top. The classic example is that we tend to think that beautiful people are more successful, good-minded, intelligent, etc., whereas ugly people are bad. In investing, the hallo effect happens a lot when we evaluate quality companies, because their past success makes us believe that they are invincible.
When evaluating apparel brand companies from a cultural perspective, the hallo effect is pretty pervasive because these companies can create very beautiful products and content, not to mention the beautiful models. Looking at apparel collections and photography is very similar to looking at art, and after some time we can get mesmerized.
Fashion, change, creativity, and style
Creativity is what brings change to society.
Fashion is the expression of that creativity and change in apparel.
Cultures and societies are not stagnant. Serdari cites Mihaly Csikszentmihalyi, the creator of the concept of flow, who defines creativity as a “process by which a symbolic domain in culture is changed. New songs, new ideas, new machines is what creativity is about.”
If apparel is the cultural message, then fashion is the change in that message, its first derivative. Because apparel is so material (it can be seen, touched, or worn) and so relevant as a cultural object, it serves as a great vehicle for creativity and change. That is why the term ‘fashion industry’ is used as a synonym for ‘apparel industry.’
The fashion cycle is similar to any adoption cycle, going from early adopters to mass, to abandonment. Some special cycles of apparel are fads (very fast cycles) and basics or classics (designs that never go out of fashion totally).
A related concept is that of style. A style is a collection of pieces with some cultural meaning. A brand can create, own, or adopt a consistent style across fashion cycles and vogues. In fact, the stronger the style across time, the clearer the creative and cultural statement that the brand imprints on society’s minds. We will return to this aspect when talking about fashion cycle risks.
Creativity differentiates designers from retailers
For mixed production and retail models, the creative content of the collection is what distinguishes designers from retailers.
In Apparel II, we divided apparel designers and retailers. The boundaries are sometimes blurry, as many designers have retail operations (Gucci), whereas many retailers have manufacturing and designing operations (Zara).
From the perspective of core competencies, what separates retailers from designers is the level of creativity and the identity of the cultural statement that the brand is making. If a brand is recognizable, identitarian, and stylish, then it is a designer brand. If a brand is known for being a trend-follower or an outright copier or carries a large variety of styles, then it is a retailer brand.
Designer brands generally pay a lot of attention to their creative teams and the role of the Creative Director, the person in charge of making the mix between apparel collections, media, and celebrities to create cultural relevance. This is why, at the very top of the apparel design pyramid, the names of the brands are the names of their mythical designers, like (Coco) Chanel, (Giorgio) Armani, (Gianni) Versace, Kenzo (Takada), and many more.
Retailers, on the other hand, are more passive. Their service to the customer is not to make creative cultural statements but to provide the venue to purchase those statements (the apparel pieces). No mega apparel retailer brand is known for its designer teams or mythical creative directors.
2. Some market segments
Apparel is fragmented, so every classification is incomplete, but knowing some general segmentations helps.
Because apparel is so fragmented, this article would be too long if I tried to be exhaustive in describing all of its segments. I prefer to reserve most of that analysis for Apparel IV, with specific examples of companies for each subsegment. However, the segments below are more general and valid for most brands.
Starting with price segments, a framework I like is Corbellini’s:
Couture: the top of luxury, inaccessible pieces, designed specifically for the wearer. This is what the movie stars wear. Economically unimportant but culturally relevant. No big brand operates solely in this market.
Ready to wear: the core of luxury. Expensive but not inaccessible, and therefore the creme of the market. Here is where all the brands with a surname live.
Diffusion or affordable luxury: a notch under ready to wear, and therefore more accessible to the top middle classes. Many surname brands have second lines here.
Bridge: luxury for the middle classes.
Mass market: accessible to middle and low classes.
A brand needs intangibles to move up the price ladder or grow within its segment. Competing in the higher segments is impossible without intangibles, and in the lower segments, it is easy to become commoditized without intangibles.
Golizia’s framework divides companies depending on how many brands are under the same company:
Specialized companies operate mainly in a single product line and price segment. Examples are Nike in footwear and Hermes in luxury purses.
Unspecialized companies operate across different lines and segments, with many brands emanating from the same cultural tree. Examples are Armani or Zara.
Groups own many companies and brands. Examples are LVMH and Oxford Industries.
He also provides a historical classification:
Heritage brands were born in the late XIX and early XX centuries, many in France. These companies tend to specialize in a single price segment, and many are strong not in apparel but in accessories. Their name indicates the focus of their intangible investment, with a strong focus on craftsmanship, origin, and quality. Examples are Hermes, Louis Vuitton, Rolex.
Designer brands are associated with mid-XX century designers, from whom they derive their names: (Coco) Chanel, (Giorgio) Armani, (Gianni) Versace, or Kenzo (Takada). This group is more specialized in apparel. The focus of intangibles is on the mythical designer and the style created.
Some contemporary brands have become unspecialized companies operating across several sibling brands. Armani and Ralph Lauren are two examples, with lines from ready-to-wear to diffusion.Industrial brands were generally born in the late XX or XXI century. They have a more massive appeal and typically do not associate their intangibles with a place, time, or person but with an idea or lifestyle. In this segment, we can also have both specialized (Nike) and unspecialized companies (Tommy Bahama).
Fast fashion brands and now ultra-fast fashion brands are the leaders of the XXI century, but they are a retail model.
Another classification that I will not exemplify here for brevity is by product line. The list includes performance, sports, footwear, purses, and a long list of styles (streetwear, casualwear, formal, etc.).
3. Challenges of apparel brands
When apparel brands grow, they tend to command high multiples and look attractive. However, three challenges will limit most brands' growth.
Apparel brands are exposed to specific challenges depending on their segments and niches but I have found three shared challenges that deserve general coverage here: the risks posed by fashion cycles, the limits to the company’s TAM, and the difficulties of integrating downstream.
These challenges are particularly dangerous for investors in young, growing apparel brands because they tend to make the companies look better in the short term.
Fashion cycle risks
Fashion cycles affect some brands more than others, depending on their operational age, customer targets and the recent momentum of particular styles.
Fashion cycles affect all brands, even those in the higher echelons of ready-to-wear ones. However, depending on the type of cycle and the brand's characteristics, the risk generated can be higher or lower.
Some cycles refer to forms, fabrics, or colors alone; these tend to move yearly. Brands can generally adapt to these changes unless they are highly specialized in a single product line. The fashion cycles that represent a more significant risk involve entire styles and the cultural symbolism they represent going in or out of fashion. Brands can still adapt to these changes but must be more active in reformulating themselves. The core message can be rephrased for the new culture. However, if the brand’s creative team lacks cultural intelligence (the ability to read these changes), the company’s sales may suffer significantly. Similarly, a highly specialized brand may have a hard time adapting.
Some characteristics that can inform us of how volatile fashion risk is for a specific company are its operational age, target customer segment, and recent style momentum.
Starting with operational age, the younger a brand has been operating at the current business level, the more attention we need to pay to fashion cycle risks. When a brand has been in the limelight for decades, and especially if the company has made financial information public, we can estimate its fashion risk from its operational history. Further, if the brand has performed over decades (in similar markets and at similar scales), then its message is probably aligned with deeper and stronger strains of culture’s fabric. It also shows that the company has been successful in adapting the message. On the other hand, if the company only has a few years or even a decade of public operational history, we need to find more evidence that it is understanding and adapting to cultural change.
Then, we have the customer segment.
Feminine fashion tends to be much more volatile, diverse, and competitive compared to what is considered the duller and more stable masculine fashion.
The younger the customer, the more exposed a brand is to changes in fashion cycles simply because generations are more diverse at earlier stages and amalgamate more as they grow. Think about how different a 20-year-old kid feels compared to a 15-year-old kid, whereas a 65-year-old man feels similar to a 60-year-old.
Finally, we have recent style momentum, using the classic adoption cycle:
Early adoption: this stage is characterized by fast growth with more growth ahead as the fashion transitions to mass adoption. It is worn by the non-conformist and creative.
Mass market: growth is massive in this stage, but it also marks the peak. If the fashion is already massive, we are probably late at riding the wave.
Decay or latency: most cycles will decay eventually, believing otherwise is fooling oneself. However, some styles will go to a period of latency and remain classic while others will shrink as they get abandoned.
TAM limitations
Apparel allows for tailored messages that provide protected niches for many companies, preventing winner-takes-all scenarios. However, this same characteristic also limits the TAM of even the most successful apparel designer examples.
As mentioned in Apparel I, apparel brands tend to have small(er) TAMs than other companies, especially when circumscribed to a single market or region. This smaller TAM is the result of brands needing to maintain message and target consistency (you cannot be everything to everyone). In the market for other producs, demand is more homogeneous (there are just a few types of dishwashers), which allows a successful competitor to have a much bigger space to expand.
Companies can try to expand their TAMs by operating abroad, creating lower or higher-priced sub-brands under the same lifestyle concept, or moving downstream to retail. Still, eventually, there is a ceiling, which is not particularly high compared to other industries, even for the companies with the broadest brand umbrella.
In Apparel I, I used a made-up example of a brand that targets high-income male teenagers. Playing with some numbers that are precisely incorrect but directionally correct :
13 million households, the richest 10% of the US population
$150 thousand average income
each household has a male teenager
2% of income, 0.5% for each member, used on apparel
30% market share
This results in a TAM of $3 billion. It's definitely enough for smaller caps, but it’s not gigantic.
In my recent reviews of companies, I have found several real-life examples. These companies (Guess, Gap, Land’s End, or Ralph Lauren) stagnated over 10 years ago. There are multiple reasons for this, but it is clear that they have reached at least a medium-term ceiling.
The case of Ralph Lauren is particularly illustrative because it is an example of a global nonspecialized contemporary/lifestyle company. These companies have the largest potential TAMs (only behind groups) because they cover several price ranges across geographical regions and product lines. Still, Ralph Lauren reached a limit.
Downstream problems
Moving from a wholesale-based channel to retail seems like a sensible move for successful brands. However, if done aggressively it will generally destroy value. Managing a large retail footprint requires specific capabilities that most apparel brands don’t have.
In general, apparel brands will do better by letting wholesale partners manage the majority of their retail operations. Managing large retail fleets is not a core competitive skill; it distracts from the core operations, and the brands might not have the economics to sustain a full-fledged retail operation. Retail should be limited to the flagship stores in key markets (New York, Paris, Tokyo, and Milano, for example). This has been the success recipe for some of the largest apparel brands out there, except the top luxury brands that control a small footprint of directly operated stores.
Sometimes, a brand doing well in wholesaling starts considering expanding its DTC segment. The business rationale has four arguments: better control of the customer experience, expanding brand visibility, capturing downstream margins, and growing faster. After the announcement, analysts can up their operating margin and sales forecasts, giving the stock a nice boost.
Early wholesale success
Moving wholesale to retail allows a company to grow revenues without actually growing (real, volume-wise) sales. This happens simply because the same products have a higher gross margin in retail. If a company has a good wholesale channel, it is easy for an expanding retail segment to steal share. The company already knows which wholesalers are doing well and has invaluable location, merchandising, and customer profile information. One potential proxy of this situation is growing sales with stagnant CoGS after trying to adjust for occupancy costs, which are sometimes included in CoGS but are channel costs. Cannibalization generates revenue growth even if the same final sales are made volume-wise, and the company is not actually growing its market.
But operating margins either stagnate or, more usually, fall. Management blames opening costs, the learning curve, and stores not reaching maturity yet. Plans for opening more efficient distribution centers are signed. The plan goes on.
Learning curve
Learning to run a large retail organization managing hundreds of stores, takes time. The current management team, running a manufacturing organization, does not have the criteria to make hundreds of critical retail decisions. Their culture, processes, and experience are in the product, whereas retail is a service. Even bringing consultants and external managers might not help. Think of the hundreds of operations decisions: location selection, decoration, advertising, recruitment, training, logistics, merchandising, etc. For a global company, add the extra complexity in logistics and operating in many jurisdictions.
Therefore, a company should move to retail only in small steps, gaining the experience necessary to make good decisions over time. Some companies rush this process, compounding the amount of mistakes made. An additional problem is that many retail decisions are difficult to revert. Once mistakes have been made in locations, countries, or acquisitions, the usual way out is impairment.
Strategic retail
Instead of making retail the strategy, it can serve strategic roles.
Flagship stores are a great way to build a brand. However, the focus is not so much on sales as on experience and traffic quality. For example, luxury brands strategically have stores in global tourist capitals. Pop-up stores are also interesting because they are explicitly considered marketing efforts.
The critical capability in these stores is brand building, which depends mostly on the (already existing) creative team. The company does not need to bring too much outside assistance. The local distributor partner might sometimes run the store for a cut or fee.
Conclusions
The world of apparel retailers is very tangible. We are concerned with operational efficiency, large structures, macroeconomic cyclicality, and operational leverage. In contrast, the world of apparel manufacturers (apparel designers or brands, in my terminology) is much more intangible.
Analyzing intangible assets requires moving outside the world of financial statements and using a framework to analyze more qualitative clues. This is where the cultural relevance framework proposed by Serdari becomes useful.
By concentrating on cultural relevance, we are dealing with the leading indicators of the financial statements. Of course, the operations also need to be profitable, and the financial results indicate if the strategy has been successful so far, but the bulk of the analysis lies in the collections, social media, and specialized outlets. Otherwise, one might fall into the trap of the bull portion of a fashion cycle or mistake a down-trending macrocycle for a brand losing relevance.
In the next article, I will dive deeper into examples of apparel brands that illustrate the framework explained here.
Citations - Resources
The Fashion Business: Theory and Practice in Strategic Fashion Management - Dario Golizia
Rethinking Luxury Fashion: The Role of Cultural Intelligence in Creative Strategy - Thomaï Serdari
Managing Fashion and Luxury Companies - Erica Corbellini, Stefania Saviolo, Jill Marie Connelly