Gap Starts Patching Its Holes

The apparel retailer is going back to core products and is adding stronger marketing. Customers are responding, as is Gap stock

By Louise Lee

Adrienne Shimkos hadn't shopped at Gap in two years. But just days ago, she emerged from a store in San Mateo, Calif., after dropping $100 on a pink jacket and blue T-shirt. "I didn't have much luck there for a while," says the 26-year-old sales clerk. "Now, the clothes are much better with the cuts and styling."

Plenty of other shoppers seem to agree with Shimkos. That's welcome news for Gap (GPS ), the onetime highflier now struggling to regain its momentum under CEO Paul Pressler. Pummeled by a string of recent quarterly losses and earnings declines, it's starting to show signs that customers might be coming back.

On Feb. 27, San Francisco-based Gap Inc., which includes the Banana Republic and Old Navy chains as well as Gap stores, is expected to report its second consecutive quarter of improved earnings. And in January, Gap reeled in its fourth consecutive month of sales gains at stores open at least a year -- a big relief after 28 consecutive months in which same-store sales slid.

"BEARING FRUIT."

  Can Gap keep it up? Analysts and shareholders attribute much of the improvement to the Gap brand's re-embrace of basic apparel, including khakis, black pants, and plain tops. "We're starting to see it's bearing fruit," says Kevin Grant, a portfolio manager at Harris Associates, one of Gap's largest shareholders. While Pressler can't take the credit for these early gains, having been on the job for just five months, he's concentrating on improving marketing, operations, and cost-cutting.

For now, Pressler is focusing largely on the Gap brand, the company's biggest division and the one most sorely in need of help. Investors are clearly betting on Pressler's marketing and cost-cutting strategy -- since his arrival, shares have risen almost 50%, to around $15 as of Feb. 21.

Some observers, though, are still skeptical of the Gap chain, which had estimated fiscal 2002 sales of $14.5 billion. Some question whether the return to basic apparel can sustain earnings growth. "They took what people bought in the past and sold lots of it at lower prices, but that's not an ongoing strategy," says UBS Warburg analyst Richard Jaffe. "You can't recycle the past year in and year out."

NEW AD FOCUS.

  Pressler acknowledges that he's not as interested in clothes themselves as was his predecessor, Millard "Mickey" Drexler. So he's leaving specific color and design decisions to Gap, Old Navy, and Banana Republic division heads. To improve Gap's general-merchandise direction and marketing, Pressler aims to step up consumer research, especially for the Gap brand.

Pressler has already hired ad agency Leo Burnett to conduct more customer focus groups and plans to send scouts to the mall to interview shoppers on why they like or dislike Gap. He also plans to require store managers to send executives regular e-mail relaying customer comments and describing any trends they spot, a task they do only sporadically now.

While none of this sounds like rocket science, analysts think Pressler's strategies can only help. "He's going to get the company much closer to the customer, so he knows what they want," says Lazard analyst Todd Slater. Pressler also expects to revamp Gap's advertising by segmenting customers by ethnicity or age and luring them with ads targeting each sector. Indeed, one shortcoming of Gap's current ads is that they "talk to all our customers in the same way," said Pressler in an interview with BusinessWeek last October.

TOO MANY STORES.

  Investors are also looking for Pressler to reduce Gap's expenses, which in five of the last six years have grown faster than sales. In particular, analysts say he may close a swath of stores. The company now has 2,340 Gaps, 446 Banana Republics, and 850 Old Navys -- all in all, too many, analysts say.

Since many leases signed during Gap's massive expansion in 1998 and 1999 were five-year agreements, Pressler this year and next has the chance to close more stores on top of the 2% square-footage reduction Gap has already announced for 2003. If he does that, he might find himself running a smaller, but better, Gap. That could make investors happier, too.

Lee covers Gap from BusinessWeek's San Mateo bureau

Edited by Beth Belton