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3 Keys to Gap's Survival

Robert Izquierdo, The Motley Fool

Savvy investors are aware of the seismic shifts gripping the retail sector. The growing dominance of online shopping, led by Amazon, has caused a rapid decline in the business of retailers like The Gap (NYSE: GPS). Gap is not alone in this predicament, of course, and its path to turning things around provides a good case study of how to tackle the challenges. Here are three things for investors to watch when it comes to assessing if Gap is on the right path.

1. Omnichannel options are the name of the game

Research shows shoppers do not want to shop exclusively online. They want options. Hence, the rise of the omnichannel retailing concept, through which retailers offer customers various avenues to arrive at the purchase point. This includes both online and in-store shopping experiences. A study by the Harvard Business Review shows this approach not only works, it boosts customer loyalty, in-store spending, and purchase amounts per transaction.

That's why the online-only companies, including Amazon, are now looking to build an offline presence. It also helps explain the resurgence of retailers like Walmart, which is building its online presence and uses its stores to outmaneuver digital-only competition in areas like grocery shopping

So how is Gap doing? The reality is that the company is still in the early innings of this ballgame. Gap's recent second-quarter earnings announcement revealed that the company's product mix did not gain traction with customers, resulting in excess inventory. 

A person reaches for a shirt on a shelf in a clothing store.

Image source: Getty Images.

Gap's Q2 financials painted a grim picture as numbers declined across the board compared to the same quarter last year. Comparable-store sales were down 4% compared to a 2% increase last year, gross margin was down 90 basis points, gross profit was down 4%, and net income plunged from $297 million last year to $168 million, a drop of 43%.

Same-store sales declines are less an issue in the omnichannel world so long as Gap's online presence can pick up the slack. But CEO Art Peck said little about the company's digital efforts during the earnings call, focusing instead on Gap's more foundational issue of product offering.

To his credit, Peck bit the bullet and spent Q2 clearing out inventory. The surplus of product necessitated deep discounts to clear it from stores, squeezing margins and leading to ugly financial results.

Peck is confident that the worst is behind Gap. During the earnings call with analysts, he emphasized the company focus on staying lean, stating that "each of our brands ended the quarter largely clean from a liability inventory perspective. We've adjusted back-half inventory buys to better match the traffic trends that we're seeing, adjusting Q3 as much as possible and even more aggressively adjusting Q4."

The company intends to focus product mix on its mainstays of denim, activewear, and fleece going into the fall and winter months. If Gap can consistently maintain a mix more in line with customer wants, then it can turn its attention to building stronger omnichannel experiences.

2. Innovation through technology is a must

With consumers embracing online shopping, a company must naturally invest in technology. Peck gets this, stating in an interview with Mad Money host Jim Cramer, "We've really been building back-end big data analytic capabilities now for a couple of years, and data is a huge asset for us."

During Gap's Q2 earnings call, Peck talked about the "technical work associated with building the platform" that would provide synergies across the Gap brands and Old Navy when the latter spins off in 2020. If this new system can provide improvements to the existing inventory management processes that weighed on Q2 results, Gap could be on the path to the streamlined, modern infrastructure it needs.

Peck also mentioned a "personalized digital experience" being tested with the company's Athleta brand. Using customer data to sell more is the core of the online shopping experience.

3. Social shopping adds a conscience to fashion

Part of Gap's turnaround plan involves revitalizing its brands, a must in the fashion world. These efforts are not merely a matter of throwing money at advertising. Today's digital environment involves far more complexity when it comes to brand revitalization.

The advent of social media has led to the concept of social shopping, wherein a shopper's friends become involved in the online shopping experience. Investors will want to watch Gap's ability to effectively integrate social shopping, which has supplanted the kind of interactions once found in malls, particularly for Gap's target audience, which resides primarily in the 25-to-35 age range. To reach this digitally savvy generation, Gap needs to engage them through channels like Instagram and via influencer marketing, where an influential person promotes brands to their social media followers.

Making social shopping even more complex is the rising importance to shoppers of issues like income inequality and climate change. Shoppers care more than ever about engaging with retailers who are not exploiting workers and contributing to the destruction of the environment, for instance.

In the social arena, Gap has made steps in the right direction. The company hired a new chief marketing officer focused on improving social connections with Gap's customers. Efforts here include Athleta's first athletic sponsorship (track and field Olympic star Allyson Felix, who is an outspoken proponent of women's rights) as well as 6-second video ad spots, which have proven successful with the demographic Gap is trying to reach.

Moreover, Gap's Banana Republic introduced a new subscription service, called Style Passport, which offers clothing rental, which the company points out should result in people owning fewer items.

During the Q2 call with analysts, Peck called climate change "a human rights issue as well as an environmental and business issue" and noted the company had recently signed its largest renewable energy contract and pointed out the company's commitment to "source 100% cotton from sustainable sources by 2025." 

These actions will build customer loyalty and help differentiate Gap from fast-fashion competitors.

Making progress

Although Q2 results seemed bleak, this is a necessary step in Gap's turnaround. While investors wait for the turnaround efforts to bear fruit, they can benefit from the stock's robust dividend yield of more than 5% at current prices. 

If Gap can continue to make strides in the social arena and technology front while reinvigorating its modest omnichannel efforts once inventory issues are resolved, Gap may very well have a bright future ahead.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Robert Izquierdo owns shares of Gap. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com