LONDON, United Kingdom — Today’s world is plagued by geopolitical conflict, terrorism, and financial crises. As a fast-moving, globally connected industry, fashion is especially exposed to this instability.
Many fashion players are developing the agility they need to respond to short-term changes, such as abrupt drops in demand that occur when tourists stay away. But truly managing uncertainty involves looking beyond the next season or year to create a business capable of thriving in a volatile environment. Managers who understand this challenge can craft a strategy designed to weather unexpected storms — and back it up with five practical steps to stay on course for the long term.
In the framework of a strong long-term strategy, disruptive periods of even two to three years are just cycles.
Volatility and the fashion business
Volatility takes many forms. Currency has been more volatile in 2016 than it was on average for the last five years. And as a study from the McKinsey Global Institute shows, global debt has grown faster than GDP. Many factors exacerbate these trends. The world is increasingly interconnected: McKinsey estimates that by 2020, some 940 million online shoppers will spend almost $1 trillion on cross-border e-commerce transactions. Industrialisation and urbanisation in emerging economies, aging populations in established markets and new technologies further complicate the mix.
Fashion faces all these challenges and more — including the partial commoditisation of the fashion market, faster fashion cycles and compliance and sustainability issues. Beyond fluctuating demand, shocks to the cost base — such as the impact of plummeting exchange rates on sourcing costs — are a constant threat. As a result, value creation by apparel and luxury companies varies much more than for the market overall, as McKinsey’s research confirms.
To stay afloat in the short term, fashion companies need a long-term vision. In the framework of a strong long-term strategy, disruptive periods of even two to three years are just cycles. The key is to take advantage of the good times in order to withstand the downturns. When setting long-term expectations, it is also important for companies to look backward and determine a margin of error. After all, as volatility increases, even the best forecasts can be wrong.
A strong strategy also involves developing the capabilities, mechanisms and tools to respond quickly to change and make sound decisions. By taking five steps, fashion companies can equip themselves to handle volatility and stay successful:
1. Adopt a consumer-driven mind-set: A granular understanding of consumer trends and the consumer decision journey is a must. It enables fashion companies to prioritise product offerings, pricing and promotions — and, importantly, to respond in real time to consumer needs that may react sharply to the volatile environment. Companies also need more flexibility when adjusting to currency fluctuations, especially the extent to which price differentials across geographies project consistency.
2. Establish operational readiness: To mitigate demand surprises, excess inventory or compliance issues, companies should increase the end-to-end transparency and agility of their supply chains. Doing so allows them to closely monitor supply risks, including financially vulnerable vendors, and manage inventories to cope with the financial impact of higher capital costs and changes in foreign exchange rates. On the sales side, retail excellence and channel management based on lean operations and best-in-class customer experience are central to retaining profits. Streamlining operations also frees up cash for companies dependent on their bricks-and-mortar stores to invest in online channels.
3. Diversify the brand, category and geographic portfolios: Diversified businesses that can reallocate resources dynamically across brands and geographies are cushioned against volatility's most extreme effects. Companies should therefore reduce their dependency on single countries, brands or category markets by diversifying their geographic footprint and/or adding or eliminating (sub)brands. Because uncertainty drives up the cost of capital, they need to review their investment portfolios and check that new investments will still pay off in a more challenging financial environment.
4. Ensure cash flow and manage costs: In uncertain times, cash is king, especially in fashion. Smart companies protect their balance sheets by raising capital while they can. Extending repayment deadlines on debt also makes sense where possible. Another key to weathering volatility — this time in terms of profit and loss — is managing fixed costs. Rent is a huge fixed cost for fashion and real estate prices and rent levels are prone to fluctuation. For this reason, reviewing the rental portfolio is critical — and a crisis can even provide an opportunity to renegotiate lease terms. Labour and other costs should be kept as flexible as possible.
5. Develop an agile organisation model: Volatility makes attracting and retaining talent more difficult. The best response for fashion companies, which have long struggled with “optimal” organisational structures, is a focus on long-term organisational health. In addition to reasserting their company values and creating agile structures to deploy resources more rapidly, they should develop programmes to optimise working conditions, such as labour scheduling (particularly for retailers), promotions and incentives.
Despite its many challenges, the fashion industry continues to generate high margins and high profits. Volatility may eat into this performance, but companies can take concrete steps to minimise its impact with a smart, long-term strategy and supporting steps to de-risk their businesses and increase agility. And volatile times can also create great business opportunities — for renegotiation, re-invention and even bargain investments for fashion companies prepared to weather the storm.
Achim Berg is a senior partner at McKinsey & Co and co-leads McKinsey’s Apparel, Fashion & Luxury Goods practice for EMEA. Leonie Brantberg is an associate partner in McKinsey’s London office, where she leads the Apparel, Fashion & Luxury Goods practice in the UK.
The views expressed in Op-Ed pieces are those of the author and do not necessarily reflect the views of The Business of Fashion.