J. Crew: Growth Through Market Segmentation

Originally published May 9, 2014 here.

WSJ reported that J Crew filed an application on Nov 25 to trademark the phrase “J. Crew Mercantile.” The name will reportedly be used to brand a chain targeted at budget shoppers.

Talks of an IPO have been buzzing for well over a year, with a slight disruption when Uniqlo was supposedly in talks to buy J Crew in an effort to bolster their US presence and aid J Crew’s entry into fast growing foreign markets, particularly in Asia. However, those talks fell through mainly due to a wide discrepancy on valuation concerns, according to inside sources. TPG Capital and Leonard Green & Partners LP acquired J. Crew three years ago and are looking for a major payday.

Thus, J. Crew is back on the IPO track and hoping for valuations in the $5B+ range. In order to qualify for that valuation, the numbers need to be rosier than they were for Q4 ’13 when net income dropped to $5.92M, down -42% (-$4.28M) vs PY, due to a highly competitive holiday season with industry-wide deep discounting.

In that context, aiming to launch a separate, lower-priced line seems like a smart move. Besides the obvious purpose of increasing the size of the target market by adding new consumer segments, diffusion lines serve two other key purposes.

1. Volume play with better margins: Rather than having to discount the main branded lines during highly competitive seasons, the diffusion line serves as a cushion of sorts. Shoppers who want the overall brand aesthetic without paying for it can shop at the diffusion line, thus allowing the parent brand to capture the sale that would have either been lost to a rival or been subsidized by discounts that eat into the bottom line. This strategy also helps to minimize brand dilution, if the branding is done right (more to come on branding implications of diffusion lines in another post).

Additionally, with items specifically produced for a diffusion line, the expectation of quality and craftsmanship are lower. Therefore the cost to produce is lower, which leads to lower prices, which means shoppers may buy in higher volumes. Thus, the diffusion line, if executed properly, can lead to higher overall market share in the retail landscape, higher revenue due to potential for higher volume buys by shoppers, and higher margins if costs and pricing are managed effectively.

2. Entry point for younger, lower income shoppers: The other key purpose diffusion lines serve is to offer an entry point for shoppers who cannot afford the main line currently, but can be primed to upgrade as they get older and make more money. As J. Crew’s price point has crept up over the years as the result of a successful effort by Jenna Lyons and Millard Drexler to pull the brand out of its early 2000s malaise through signature styling and improved quality, much of the college and young professional crew has been somewhat alienated. $80 cotton sweatshirts and $120 pencil skirts are next level aspirational purchases for the college set and young 20-somethings who make $45k a year. Therefore, with all the options available when considering expansion, the diffusion line makes the most strategic sense as the college kids and 20-somethings were J. Crew’s bread and butter before the price increases. J. Crew still understands that market and has experience with it along with the advantage of lessons learned. Capturing shoppers earlier in life can translate to higher LTVC for the parent brand by bringing them into the portfolio early and maintaining their loyalty.

If all of this sounds familiar, that’s because it is. It’s what J. Crew CEO Millard Drexler did when he was CEO of Gap. He launched Old Navy.

No doubt J. Crew has assessed market segments / potential verticals and continues to assess these options thoroughly. Avenues for growth through market segmentation include potential entry into or growth in the following verticals.

• Outlets: J. Crew already has 96 Factory stores in major outlet malls. Curious to see how Factory will interact with J. Crew Mercantile. Imagine Factory stores inventory is very similar to what the Mercantile stores will carry so the Factory stores could either fold into the Mercantile brand or the Factory stores could change into a true outlet selling J. Crew inventory excess. Due to the number of Factory stores, I doubt there is enough inventory excess and would think they will sell the same merchandise as Mercantile and ultimately fold into Mercantile brand.
• International: J. Crew announced plans to open in Europe and Asia. First stores will open in London and Hong Kong. Exact timing is TBD, but I would expect 2014 or early 2015.
• Weddings: J. Crew has done a nice job in this area, tapping a market for those who wanted an un-fussy, contemporary aesthetic for their weddings; a counterbalance to the couture or couture inspired set (Vera Wang, Amsale) or off the rack strip mall set (David’s Bridal).
• Prestige Lines: Two possibilities here and both could be executed simultaneously. J. Crew could launch its own prestige line that would directly compete with Helmut Lang, Tory Burch, Emporio Armani, etc. with average price points for a basic top in the $200 — $400 range. It could also leverage Madewell to be more of the contemporary lux brand within the portfolio. Madewell has dabbled in micro-collections in partnership with niche contemporary lux talent such as Mara Hoffman and Rachel Comey. This positioning for Madewell might be something that J Crew is already testing. Gap acquired Intermix in order to achieve the same mix within their portfolio.
• Men’s and Children: Done and done, although children’s is something that could definitely expand further.
• Home Decor: Major opportunity here to take on brick and mortar + e-comm stores like Restoration Hardware, Williams-Sonoma, Pottery Barn or pure e-comm like Serena and Lily and One King’s Lane. Clothing may be at the heart of J Crew’s DNA, but the aesthetic they sell translates nicely into home decor. I don’t have the data to run the numbers, but would venture that despite existing competition, the market size is large enough and growing at a solid clip. It is practically inviting additional players with strong brands with differentiated points of view. There is also opportunity for share stealing from existing players. Tory Burch is testing the waters.
• Lingerie: Another opportunity to expand deeper into this underserved market. How Victoria’s Secret still holds the majority here is unbelievable. Oh yeah…they are in every mall in America. Gap has made some inroads no doubt based on their equally large footprint across the US, but their designs are mainstream, dull, and not special in any way. Gap Body screams comfort, basic, “I don’t really care” vs fun, sexy, classy or anything remotely exciting. Teen focused lines have demonstrated staying power (Aerie), but there is an enormous unmet need here since there are large segments of women who are not well served. Upstarts such as Negative and Third Love are taking this market on due to consumer dissatisfaction, but it’s a tough market to crack without significant resources to battle VS. J. Crew has the resources and could further expand their presence here to do very well.
• Athletic Wear: If lingerie does well, the natural next step would be athletic wear. One could argue that athletic wear is so hot right now that J Crew could lead with this. If starting with swimwear (which J. Crew already does well) as a bridge to athletic wear, then this is a highly viable opportunity.
• Accessories: Handbags, shoes, scarves and jewelry. J. Crew already does well with these items and it is another good opportunity for expansion. Margins are historically high on these items so deeper focus on this may be another close-in growth opportunity for J. Crew.

All in all, launching a lower-priced diffusion line appears to be a sound strategy at this time. Expecting to see accelerated growth plans through expansion into more verticals and international markets in the pre-IPO timeframe.

There’s still a lot to explore here from a strategy perspective including branding implications for the portfolio, competitive landscape analysis, etc.

Originally published at https://www.tumblr.com.