Lululemon's Secret Sauce

Scarcity Built a $10.4 Billion Retailer—But Will It Prevent Lulu From Growing?

By DANA MATTIOLI

Lululemon stokes demand by keeping inventory scarce and setting up stores so employees can eavesdrop on shoppers, Dana Mattioli reports on the News Hub. Photo: Getty Images.

When Lululemon Athletica Inc. reports earnings Thursday, the apparel chain with a tech start-up's valuation is expected to tell investors its sales grew strongly for the 12th consecutive quarter.
The mystery is how the chain has managed to turn yoga gear into a miniempire, notching a market value of $10.4 billion with sales of just $712 million last year, and whether it can sustain the pace. After all, last quarter, it booked a record $1,800 in sales per square foot—more than three times luxury kingpin Neiman Marcus's sales for its most recent full year.
In a series of interviews, Lululemon's executives explained the chain's strategy for stoking demand for Wunder Under pants, Scuba hoodies and racerback tanks. Unlike most retailers, Lululemon doesn't use software to gather customer data, doesn't build lots of new stores, doesn't offer generous discounts and purposely stocks less inventory than it can keep on its shelves.
Instead, the Vancouver company stays in close contact with its customers and cultivates a sense of scarcity, and during a time when most retailers have used discounting to drive sales, it uses pricing power to its advantage to keep items flying off the shelves.
The moves are largely the idea of Chief Executive Christine Day, who took the top job in June 2008, and so far they have paid off.

Over the past three years, the company has posted nine quarters in which sales rose 30% or more from the year before. And its stock has doubled in the last 12 months, giving it a higher market value than much bigger J.C. Penney Co.
Analysts expect Lululemon to post growth of about 50% in profit and revenue for its fiscal fourth quarter, according to Thomson Reuters. Now Ms. Day needs to show she can keep the company's rapid growth going.
"I think across the board it's going to slow—earnings, revenue and margins—just because of how fast and how quickly this brand has grown," says Brian Sozzi, chief equities analyst for NBG Inc., an independent research firm in New York. "The law of large numbers eventually catches up to these retailers."
Snowboard and surfing retailer Dennis "Chip" Wilson founded Lululemon after his first yoga class in 1998. Lulu's first store opened in 2000, and the company went public in 2007. Mr. Wilson is still the chairman.
In its most recent quarter, sales growth at stores open at least a year softened—to 16% from 29% a year earlier—but was well above industry norms. Margins also slipped because of higher product costs. Some say the company is overvalued, but others note it still has options like international expansion that could be a source of more growth.

Rob Bennett for The Wall Street Journal

Lululemon, which sells yoga gear, had sales of $712 million last year. A New York store shown here.

"When you see a price to earnings of 48 times earnings, it obviously seems much higher than a number of other retailers," says Jaime Katz, an analyst at Morningstar. "But the growth opportunities are better," she says. Other better-known retailers like Limited Brands, Gap Inc. and Aeropostale Inc. are trading at less than half the price to earnings ratio of Lulu.
When it comes to making decisions, Lulu has gone back to basics. It doesn't use focus groups, website visits or the industry staple—customer-relationship management software, which tracks purchases.
Instead, Ms. 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.
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.
In the most recent quarter, the company made logistical changes so it loses fewer sales from products being out of stock. For instance, it has focused on getting core products that don't change from season to season, such as black yoga pants, into its stores, while keeping limited-time items scarce.
Lulu also sells 95% of its gear at full price, says Chief Financial Officer John Currie. Its pants range from $78 to $128, while lower-priced competitors like VF Corp.'s Lucy brand and Gap Inc.'s Athleta each have yoga pants on sale on their websites in the $25 to $50 range.
The company never puts its core items on sale, and it has a very strict return policy: no products accepted after 14 days, and all must be unwashed and unworn, with original tags.
"We aren't Nordstrom," Ms. Day says. "We aren't your personal shopper."