Part 1 Comprehensive Case

Abercrombie & Fitch Co.: Looking to the Future*

* The material in this case is adapted by the authors from Trefis Analysis for Abercrombie &
Fitch Co. (Boston, MA: Insight Guru Inc, May 26, 2011). Reprinted by permission
of Trefis.com.

Introduction
Abercrombie & Fitch Co. (www.abercrombie.com) is a specialty retailer that operates stores
and Web sites that sell casual sportswear apparel, including knitted and woven shirts, graphic T-
shirts, fleece, jeans and woven pants, shorts, sweaters, outerwear, personal care products, and
accessories for men, women, and kids under the Abercrombie & Fitch, Abercrombie, and
Hollister store names. It also has stores and a Web site selling underwear, personal care items,
sleepwear, and home products for women under the Gilly Hicks brand.

Company Background
Abercrombie & Fitch Co. (A&F) has three main store divisions. Its Abercrombie & Fitch stores
are more valuable than Hollister stores and Gilly Hicks & abercrombie kids stores for the
following reasons:

 Hollister stores are more in number, but A&F stores are larger in size. Hollister has about
1.5 times the number of A&F stores, but the average size of an A&F store is around 1.3 times
the average size of a Hollister store.
 Abercrombie & Fitch stores are positioned as a premium-priced brand, targeting women
in the upper income segment. The company views the “in-store experience” as the primary
vehicle for communicating the spirit of the brand. To ensure this, the company is acquiring
larger retail spaces for its new stores as well as remodeling some of the existing ones to
increase their retail space.
 The average revenue per square foot for A&F stores was $451 as of 2010 compared to
$368 for Hollister stores and $317 for Gilly Hicks & abercrombie kids stores. As the
economic environment improves and consumer spending increases, we expect revenue per
square foot for A&F stores to cross pre-recession levels and reach nearly $550 by the end of
our forecast period of 2017.
 Abercrombie & Fitch stores have profit margins of 15 percent or more, which are
considerably more than profit margins for Hollister stores or Gilly Hicks and abercrombie
kids stores. The unique identity of the A&F brand as being premium—as well as exclusive—
enables it to sell products at higher price points than the Hollister brand, thus obtaining
higher profit margins.

Key Trends

Declining Apparel Demand Due to Economic Downturn

The apparel industry witnessed a short-term decrease in demand because of the economic
downturn during 2008–2009 that led to a considerable fall in consumer spending. This
significantly impacted the revenues of major specialty retailers such as Abercrombie & Fitch,
whose revenues declined at an annual rate of 11.6 percent of from 2007 to 2009.

Increasing Competition from Department and Discount Stores

In the competitive apparel industry, the local department stores and discount store chains have
been scaling up their operations. As a result, the larger national department stores and specialty
store chains such as Abercrombie & Fitch, faced with shrinking margins, need to increase their
operational efficiency to remain profitable.

International Expansion
With strong comparable sales growth at its international stores, particularly in Great Britain,
Abercrombie & Fitch is looking to further expand its presence in Europe. In addition to this, the
firm plans to take advantage of the growing Asian market, which is becoming a focal point of the
global retail industry, with major retailers across the globe speeding their plans of growing their
presence there. As Asian consumers, backed by good disposable income, are showing an interest
in luxury goods, Abercrombie & Fitch can leverage its image to gain a foothold in this market.

Retail Store Divisions

Abercrombie & Fitch Stores

The Abercrombie & Fitch stores (AFS) division has solid sales per square foot of retail store
space, with 2010 revenues of $451 per square foot. This figure is projected to reach $548 per
square foot as of 2017.

The revenue per square foot for AFS had crossed the $450 mark before the recent economic
downturn. Unlike many other retailers, AFS did not offer discounts to boost sales during the
downturn. Though this impacted its sales, it helped to maintain the luxury image of the brand,
which would help to boost its comparable store sales as the economic environment improves.

The company’s international AFS unit has been reporting strong sales; and the firm believes that
there is tremendous upside in its international business. The Asian market presents a great
opportunity for the company to expand its A&F brand as there is a growing demand for luxury
apparel in this region and an increasing percentage of population in the age group 15 years to 25
years, which the firm primarily targets. It opened a flagship store in Tokyo, Japan, in fiscal 2009
and is planning to add more stores at up-market shopping destinations in these regions.
Currently, international store sales account for 8 percent to 9 percent of its total sales; but, as
noted, the company sees significant potential.

To succeed in the future, AFS needs to correctly gauge rapidly changing trends in a highly
competitive fashion industry—and adjust its product offering accordingly. In the first quarter of
2009, AFS missed some key trends, which significantly contributed to a fall in sales compared to
quarter one of 2008. In addition, the pace of the economic recovery impacts the company’s
revenue per square foot. Because of the slow and prolonged economic recovery process, the
demand for the brand’s products has been slow to pick up, as customers have shifted to lower
priced brands. During the worst of the economic slowdown during 2008–2009, spending by
upper income consumers declined by 9 percent and spending by teens dropped 20 percent.

It is expected that the average square feet per store for AFS will continue to rise into the future,
as it is in line with the company’s plans of having a larger retail space for its new stores. AFS
views the “in-store experience” as the primary vehicle for communicating the spirit of the brand.
To ensure this, the company is acquiring larger retail spaces for its new stores as well as
remodeling some of the existing ones to increase their retail space. On the other hand, AFS has
seen a consistent increase in its operating expenses since 2005, which has significantly cut down
on its operating margins. To increase margins and reduce average unit costs, the company is
looking to consolidate its business by closing down some underperforming stores and increase
the size of strategic stores.

When acquiring new retail space at a location, the company has to trade off between the cost of
retail space and the expected demand for its products. In the current economic environment, and
with the real-estate market being volatile, the company may have to be more economical in
obtaining space.

Hollister Stores
The revenue per square foot for Hollister stores increased to around $520 in 2007. This was
largely due to a positive macroeconomic environment during this period, which was driving
demand in the apparel industry, and the company’s success in marketing the Hollister brand.
However, it decreased to about $326 in 2009, an annual negative growth rate of roughly 20
percent from 2007. This was largely due to falling demand in the apparel industry, especially in
the luxury segment, as a result of the economic downturn. The revenue per square foot increased
to $368 in 2010. Going forward, it is expected that the division’s revenue per square foot will
show a positive trend and reach the $490 mark as of 2017.

Hollister’s strategy is driven by innovative marketing. For its Hollister brand, A&F uses the
walking self-advertisement technique, wherein people who are wearing the company’s clothes
advertise the products because there are usually large prints of the brand’s name, logo, initials,
and fictional date of establishment on most of their clothing items. In addition to this, many of
the models who advertise the brand’s products also sell the products in the stores. These
marketing tactics had been working successfully for the brand before the economic slowdown
and are expected to further contribute to generating demand once consumer spending picks up.

Hollister’s 2007–2009 sales decline was not only due to falling consumer spending; the brand
lost market share to competitors such as American Eagle and Aéropostale, which also offer
trendy clothing, but at a discount to Hollister prices. These competitors, which are becoming
increasingly popular in the teen clothing segment, will be adopting aggressive marketing
strategies to hold on to their increasing market share as the economic environment improves.
As the company aggressively marketed its Hollister brand in the United States, it increased the
number of stores from around 320 in 2005 to 540 in 2010 (compared with 325 for AFS). Going
forward, a further increase in the number of Hollister stores is projected, though at a slower rate,
as the company expands its business both in the United States and internationally. As the
economy recovers, A&F expects demand for Hollister products to pick up and cross historical
levels. A&F would have to expand its capacity to meet the future expected demand by increasing
the number of stores. Currently, the firm only has a few Hollister stores in Europe, which have
been giving encouraging results. The growing Asian retail market is where A&F predicts
maximum growth potential and is planning to expand its presence in the region.

The square feet per store for Hollister stores rose slightly between 2005 and 2010. It is projected
that this trend will continue into the future, in line with the company’s plans of having a larger
retail space for its new Hollister stores, especially at international shopping locations. A&F will
be adding flagship stores and mall-based stores in Europe and Asia. These stores are expected to
have larger retail space that will help A&F to sell the brand’s luxury image in these new global
markets. The company is also remodeling better-performing existing stores to increase their
selling space and further improve their productivity.

To promote its Hollister brand globally, A&F has identified specific up-market shopping
destinations, especially in growing Asian markets. However, commercial real-estate at these
locations is becoming very expensive, and in the current economic environment, the company
may have to be more economical when acquiring retail space.

A&F put controls on Hollister’s operating costs by reducing its marketing, general, and
distribution expense by nearly 13 percent in 2009 and keeping its store and distribution expense
almost flat through 2010. The company sees further opportunities for optimizing its operations to
reduce costs.

The Hollister brand operates in a very competitive environment. Revenues are largely driven by
its ability to successfully gauge changing fashion trends and consumer preferences.

Gilly Hicks and abercrombie kids Stores

Gilly Hicks is a newer store concept that features apparel and undergarment items for young
women. As its Facebook page (www.facebook.com/gillyhicks) notes: “Fun, casual, and sexy
with a Sydney [Australia] sensibility, Gilly never takes herself too seriously. Free-spirited and
beautiful—perfect for the All-American girl.” The abercrombie kids stores offers Abercrombie
& Fitch style clothing that is targeted especially for boys and girls.
The revenue per square foot for these stores decreased from $460 in 2005 to $286 in 2009,
before rebounding to $317 in 2010. Not only was this due to falling demand in the apparel
industry, especially in the luxury segment, as a result of the economic downturn, but the
unsuccessful launch and marketing of the now-defunct Ruehl store brand. Going forward, it is
expected that sales per square foot will rise to nearly $400 as of 2017. A&F has successfully
established a marketing platform for its newly launched Gilly Hicks store brand.
Increasing demand for luxury wear in the children’s apparel market is projected largely because
of the trickle-down effect from growth in the luxury market for women’s and men’s wear, into
the luxury market for children. The abercrombie kids store brand can leverage the luxury
heritage of the established Abercrombie & Fitch brand to grow in this market.

The Gilly Hicks store brand is operating in a very competitive market segment. The intimate
apparel marketplace already has a large number of established players. Before it can capture a
significant portion of that customer base, A&F would need to build the brand’s image
considerably.

Between 2005 and 2010, A&F gradually increased the number of abercrombie kids and Ruehl
stores and launched Gilly Hicks stores. Although the company discontinued its Ruehl store brand
in fiscal 2009, it is forecast that A&F will continue to expand its abercrombie kids and Gilly
Hicks business in the United States and then internationally by increasing its fleet of stores for
these brands.

Despite the competition, there is huge potential in the intimate apparel market. The global
lingerie market, which declined at an annual growth rate of 1.6 percent between 2007 and 2009,
is expected to increase at an annual growth rate of 1.5 percent and reach a value of $32 billion by
2016. By aggressively growing its Gilly Hicks store, A&F feels that these stores can leverage the
strength of its already established brands and capture sizeable market share by 2016.

Again, if the economic recovery is slower in the next few quarters, the company would have to
significantly reduce its annual sales target. This would affect its plans for expansion as A&F
would only be comfortable with increasing its capital expenditure only if it sees a comparable
growth in revenues.

A&F gradually increased the square feet per store for Gilly Hicks and abercrombie kids from
2005 to 2010. This trend is expected to continue into the future. This is in line with the
company’s plan of remodeling better-performing stores to increase their capacity and also
develop new stores, which would be larger than existing average stores. However, if revenue per
square foot from these stores does not increase in the near term, A&F may have to cut down on
plans for expanding their average size.

A&F wants to enhance the marketing platform for these brands. To aggressively expand its
abercrombie kids and Gilly Hicks store brands, the company expects to adopt a similar
marketing strategy to that used by the AFS and Hollister brands.

Internet and Catalog Orders

The Internet and Catalog Orders division revenues increased from $120 million in 2005 to $352
million in 2010, driven by growth in online sales due to increasing Internet penetration. It is
forecast that these revenues will increase to more than $930 million as of 2017 due to the
continuing rise in the direct (online) channel and the popularity of E-commerce. This business
represents a major revenue expansion opportunity for Abercrombie & Fitch.
A&F is gaining popularity through social media channels. It has a growing following on social
networking sites such as Facebook and a growing customer base on its mobile commerce
channel. The company is making significant investments in new marketing initiatives, which
includes offering engaging offers and promotions through its direct channels. The aggregate
number of unique visitors to the company’s retail Web sites has been increasing strongly on an
annual basis.

The benchmark key performance indicators (KPIs) for the direct-to-consumer channel are
expected to become more competitive. To do this, the company needs to continuously optimize
its supply chain to keep in line with industry benchmarks like lead time, turnaround time, and so
forth. Already, the Internet and Catalog Orders business has been able to scale up operations
efficiently, benefiting from the operating resources of the company’s store divisions.

Between 2008 and 2010, A&F reduced the operating expenses related to its Internet and catalog
business by about 10 percent annually. This was largely due to the business benefiting from the
company’s large operating resources. The company believes that there is further scope for
optimizing these operations. However, going forward, efficiency may decrease slightly and then
remain flat as A&F incurs higher operating expenses as this business expands outside the United
States. The company has made plans for expanding its online business to Canada and Europe.

Summing It Up—By the Numbers

Companywide, Abercrombie & Fitch generated total revenues of $3.47 billion in calendar year
2010. This is forecast to rise to $5.48 billion in calendar year 2017. Its overall gross profit as a
percentage of revenue is projected to increase from 15.6 percent in 2010 to 23.3 percent in 2017,
due to operating efficiencies in each of the firm’s divisions, higher sales per square foot, and the
greater importance of the high margin Internet and catalog business