Gap Cost Cutting Won't Fashion a Turn Around

While some retailers can cut costs and wait for the economy to turn around, austerity moves, no matter if well intentioned and executed, won’t position Gap for recovery as its three major divisions have lost their connections to customers.

In its latest move to save money, Gap is reducing the size of its board from 13 to 10 members while cutting the 2009 cash retainer and stock compensation for remaining board members by 15 percent. Additionally, Glenn Murphy, the company’s chairman and CEO will take a voluntary 15 percent cut in his annual salary.

The move is consistent with efforts by other major companies to reduce board-related expenses in the recession, and it may have been affected, too, as a way to soften the blow of a decision to eliminate 2009 merit-based salary increases for most headquarters employees.

Management at Gap is taking appropriate steps to deal with tough times, including closing some stores, but the kind of sales and traffic declines it is trying to manage go back a lot longer than the start of the recession and signal why cost cutting and tight inventories aren’t enough to sustain the company.

Gap has endured a long period of declining top line and comparable store sales. In fact, 2003 was the last year the company posted positive annual comps. Full-year fiscal 2008 comparable store sales slid 12 percent after a four percent comp decline in the annum earlier. 0verall 2008 revenues declined to $14.5 billion from $15.8 billion in fiscal 2007.

Yet net earnings increased by 16% in the latest fiscal year to $967 million while earnings per share gained 28% to $1.34.

In the fourth quarter, despite declining overall and comparable store sales, Gap managed to cut SG&A expenses and boost gross margin. Morningstar analyst Joseph Beaulieu pointed to that kind of managing as the major reason the company’s financial position remains solid, with about $1.8 billion in cash on the balance sheet, little debt and the ability to continually generate strong free cash flow.

Still, Gap’s prospects are clouded. Once a must-check-out store for casual fashion, Gap never really adapted to being on of many mall-based fashion basics players for young adults. And it continues to have problems finding a core customer base, Beaulieu noted. For awhile, Old Navy buoyed the company, with its lively television commercials and good quality, inexpensive takes on trends, but it, too fell out of favor as its big box competitors got better at doing the same thing and stores got too cluttered and too reliant on discounts. Banana Republic built a solid business that it maintained for years but the department store alternative is trying to deal with a tougher competitive environment as its rivals have become more aggressive in targeting young adults.

Gap store closures will weigh against its namesake brand, replacing some singular stores with combinations that also include GapKids and babyGap operations. It  has gone back to basics with Old Navy, introducing vivid, irreverent ads staring colorfully dressed, and occasionally undressed, “Supermodelquins” charged with charming the company’s current core customer base, budget conscious young moms, but it doesn’t seem to quite know what to make of the traffic declines at Banana Republic. In discussing Gap efforts to tweak the Banana Republic merchandise mix in a fourth quarter conference call, Murphy could only conceded that sales there had been “disappointing” and that the company is still appraising how to take advantage of the chain’s affordable luxury positioning in tough economic times.