FOCUS: Zara grows in Brazil while Gap and H&M dither
Zara remains ahead of the fast fashion game
Over the past five years, retail sales of apparel generated stronger incremental growth in Brazil, at constant US dollar prices, than anywhere else in the world except China.
Yet H&M and Gap Inc, the second and third biggest clothing players in the world respectively, have yet to grab a piece of the action. The world's leading apparel company Inditex, meanwhile, has been achieving double-digit annual growth rates in Brazil for more than a decade.
Are the conditions right for H&M and Gap Inc to build stronger southern hemisphere positions, or has the best of the opportunity slipped away? Euromonitor International investigates.
Inditex boosted by homespun production model
It is hard to look at the latest round of quarterly financial results from the world's leading fast fashion players and not conclude that Sweden's H&M and the US's Gap Inc are at risk of losing significant ground to Spain's Inditex unless they raise their game in emerging markets.
Net profits at H&M were down 18%, and there was a comparable slide of 21% at Gap for the 13 weeks ending 30 April. In contrast, net profits at Inditex were up a bullish 10%.
Tellingly, Inditex also dethroned H&M as the biggest clothing retailer in the world by market capitalisation in August. This was a key milestone in terms of comparative investor confidence, even though Inditex has effectively been the biggest clothing player in the world by retail sales performance since 2008, according to data from Euromonitor International.
H&M and Gap Inc are not only battling high cotton prices, they are also heavily exposed to rising production costs in Asia. H&M, for example, sources and produces around three-quarters of its products in the region.
Rising wage inflation in China is a critical problem. Such is the concern about rising costs in China that Gap, which makes around 27% of its products there, plans to transfer production to lower cost countries such as Vietnam and India by 2015.
Inditex, in contrast, operates a strong homespun production model, with around half of its products made either in Spain, Portugal or nearby Morocco, and only 35% in Asia.
As H&M tries to retain market share by not passing on hikes in production costs to the consumer, so its bottom line has inevitably become squeezed. Gap, meanwhile, has slashed its full-year profit outlook, saying that unit costs will rise by around 20% over the second half of this year.
Gap and H&M over-dependent on Western consumption
It is in emerging market penetration that H&M and Gap are most at risk of losing ground to Inditex.
For example, the under-performing Western European market accounted for some 84% of H&M's retail sales in 2010 compared with 65% in the case of Inditex, according to Euromonitor International. In the case of Gap, the US fuelled almost 80% of its retail sales last year.
And these regional disparities are set to grow over the short to medium term because some 80% of new store openings from Inditex in 2010 were in the emerging markets, compared, with around 32% for H&M. This year, H&M plans 35 new stores in China, the fastest growing fashion market in the world, but Inditex is planning almost three and a half times that number.
The comparatively weak emerging market footprint of H&M and Gap is nowhere more evident than in Brazil, where neither has any presence and where apparel retail sales generated in excess of US$12bn of incremental value between 2005 and 2010 (at constant US dollar prices).
In contrast, absolute growth in Germany, H&M's largest market (accounting for 24% of its global retail sales in 2010) was a paltry US$4m. And over the corresponding period in the US, which is Gap's dominant market, apparel sales were down a whopping US$25bn.
Summer and winter seasons on stream
By nature of its southern hemisphere location, Brazil is a tricky market for a Western clothing company as the seasons are directly opposite to those in their trendsetting northern hemisphere consumption bases.
One might assume that a retailer could simply parachute its European spring collection into Brazil later in the year. But Brazilians (and Argentinians too) are far too fashion savvy to tolerate that type of hand-me-down strategy.
And herein lies a key difficulty: Western clothing companies with big ambitions in Brazil ideally need to design fashion lines specifically for southern hemisphere seasons.
Inditex, through Zara, has started to do precisely that and, as such, is again ahead of the fast fashion game. In 2010, retail sales through Zara's Brazilian outlets reached US$282m, according to Euromonitor International. But that amount is likely to rise sharply in 2011 and 2012, fuelled by its new southern hemisphere collection across more than 30 outlets.
It might seem counter-intuitive to ramp up production difficulty factor at a time when sourcing costs are going up, but that is what H&M and Gap will have to do if they are to break into Brazil and claw back some of the gains being made by Zara, which is building a stronger Brazilian position month by month.
Other fast fashion players are also coming into the affray, which will raise the competitive tempo. The UK's Topshop/Topman, for example, plans to open its first Brazilian outlet in the first quarter of 2012. Indeed, the brand is identified as already having plenty of kudos among young South American fashionistas and is likely to do well.
It will not all be plain sailing in Brazil. In terms of the macro economy, inflation is climbing despite some of the highest interest rates in the world, while consumer credit is running at dangerously high levels and the local currency is heavily over-valued.
However, these are variables that could equally play out well for the cheap chic fashion model as middle-income consumers trade down from more expensive clothing lines.
The north east of the country is also developing rapidly, and bringing literally millions of consumers into the formal retail channel for the first time ever. Indeed, to 2015, Brazil's apparel market is projected to generate almost US$3 billion of incremental retail sales a year, according to Euromonitor International.
H&M and Gap missed the boat in terms of the first stage of Brazil's fast fashion growth trajectory, and in so doing allowed Zara to gain the initiative. However, there is much more growth in Brazil yet to come, with knock-on upside implications for demand in Argentina and Chile too.
The whole of South America is still a budding opportunity, and one that ought to be viewed as simply too good to miss.
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