How Does Lululemon Keep From Stocking Lemons?

| About: Lululemon Athletica (LULU)
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By Marty Lariviere

Lululemon (NASDAQ:LULU) is undoubtedly on a tear. According to the Wall Street Journal (Lululemon's Secret Sauce, March 21), the Canadian retailer has higher sales per square foot than Neiman Marcus and its price to earning ratio is 48. How does it manage this? A lot has to do with its management of its assortment and its inventory. Check out this eye candy:

The first thing to note here is an explicit decision not to go the Big Data route.

[Chief Executive Christine] Day spends hours each week in Lulu stores observing how customers shop, listening to their complaints, and then using the feedback to tweak product and stores. "Big data gives you a false sense of security," says Ms. Day, who spent 20 years at Starbucks Corp., overseeing retail operations in North America and around the world.

On a December store visit in Whistler, British Columbia, Ms. Day noticed that women trying on a certain knit sweater found the sleeves too tight. After asking store associates if they had heard similar complaints, she canceled future orders.

Lulu also trains its workers to eavesdrop, placing the clothes-folding tables on the sales floor near the fitting rooms rather than in a back room so that workers can overhear complaints. Nearby, a large chalkboard lets customers write suggestions or complaints that are sent back to headquarters.

One of the people discussing the article seems very dubious of this approach, but it may make some sense given the chains relatively small (say, compared to The Gap) size and its focus on fast-moving, short-lived styles. Many items are not meant to be on the shelves that long so the time window in which heavy analytics can be helpful may be very small.

The second part of Lululemon's strategy (which we have touched on before) is its willingness to understock.

While a large part of Lulu's strategy is getting the product right, an equally important part is keeping it scarce. The goal is to sell gear at full price and to condition customers to buy when they see an item rather than wait. "Our guest knows that there's a limited supply, and it creates these fanatical shoppers," says Ms. Day.

New colors and seasonal items get three, six or 12-week life cycles so stores feel fresher. Sheree Waterson, Lulu's chief product officer, says a hot-pink color named "Paris Pink" that launched in December was supposed to have a two-month life cycle but sold out its first week.

The strategy has sparked some concern on Wall Street. Conference calls with analysts often center on Lulu's inability to stock enough items.

To put this in perspective, the article reports that 95% (!) of its sales are at full price.

This is just an interesting tradeoff. On the one hand, there is a stocking quantity one would pick if the distribution of the number of customers coming in the store were just fixed. On the other, there is the distribution of demand that one sees as customers learn how the firm stocks and how it discounts excess inventory. If one actively manages that distribution, it may look like the firm understocks and runs out too often.

This is not to say that Lululemon has nailed this problem. Rather, I am just observing that its routinely stocking out of its more fashion-oriented SKUs is not necessarily evidence of incompetence. Further, it is managing a delicate balancing act. If it misjudges one season, orders too much, and ends up with significant discounts, it may never manage to move customers back to the equilibrium where they accept having to pay full price to get the right color and size.