The Gap Has Reason To Dance Again

CEO Pressler's tighter operations and customer focus have profits hopping

The humble clothes hanger is as good a symbol as any for Paul S. Pressler's turnaround at Gap Inc. (GPS ). Following Pressler's directive to make stores more shopper-friendly, execs at the retailer's Old Navy unit added color-coded tags to hangers a year ago to make it easier for customers to find the right size. That has helped boost sales. Now, thanks to a host of such small changes, Old Navy is cruising once again: Same-store sales rose a solid 8% in 2003 and have continued to climb this year.

No one expected Pressler to launch a fashion makeover at Gap when he took the reins in 2002. After all, his predecessor, Millard "Mickey" S. Drexler, had already revived Gap's merchandise just before he left, bringing back khakis and other favorites. But plenty of other problems remained. And now Pressler, a former Walt Disney (DIS ) Parks & Resorts chief with little prior apparel experience, has given Gap's turnaround staying power by focusing on such basics as operations, inventory, and market research. The San Francisco-based clothier has posted six quarters of earnings growth. March sales, to be announced Apr. 8, are expected to be up 5%, the 18th straight month of gains. Said Pressler in February: "We've positioned [Gap] for long-term growth."

The question now is, exactly how long can Pressler fuel growth by eking out operating improvements? Paradoxically, Pressler's turnaround has gone so well that investors are starting to wonder what Gap's next act is. And that could prove to be a bigger challenge: To keep Gap growing, some argue, Pressler will have to find a whole new kind of customer -- one who doesn't currently shop at the company's Gap, Old Navy, and Banana Republic stores. Gap's projected annual sales growth of 4% to 5% "is not going to do it in the future," says David N. Dreman, chairman of Dreman Value Management, which holds 3.8 million Gap shares. "Something has to be done in a few years."

Pressler can probably afford to wait a year or two before making a big move. For now, Gap will likely continue to boost sales by giving customers whatever his market research indicates they want. Unlike Drexler, Pressler stays out of his designers' way. Instead, he has emphasized focus groups and surveys to tease out customer preferences, be it more petite sizes at Banana Republic or stretchier waistbands at Old Navy.

Elsewhere, too, Pressler still has room to run. By keeping orders lean and reducing the amount of clothing in warehouses, Gap says it expects inventory per square foot -- some $55 a year ago -- to decline by roughly 12% to 16% this quarter. Pressler is also aiming for healthier gross margins by selling clothes closer to full price. In an effort to end panicky clearance sales, he has ordered managers to rely increasingly on software that tells them when and by how much to mark down merchandise.

But Gap's fundamental problem remains: It has expanded about as far as it can go -- and Pressler seems to understand that. While declining to be interviewed, he says in a statement that Gap's research "tells us those markets that we do not serve or underserve.... It could lead to new brands or acquisitions over time."

While Pressler offers no hint of what those might be, Wall Street figures Gap is more likely to start a new chain than buy one. Gap has no experience with acquisitions, apart from its 1983 purchase of Banana Republic, which then had just two stores. By contrast, it has been adept at developing new brands. Beyond remaking Banana Republic, its hugely successful Old Navy chain, launched in 1994, now accounts for 41% of sales.

Of course, Gap would have to find a niche it doesn't now cater to -- and do so in a market that's far more over-stored than a decade ago. Targeting boomer men is one prospect, say analysts. "There's no place for guys who aren't Banana-Republic skinny," says Richard Jaffe, an analyst at UBS Investment Research (UBS ).

Will Pressler make such a move? Outsiders figure he'd better start working on concepts now so a launch is ready by the time the big gains from improving operations run out. "Management needs to focus three years out," says Todd D. Slater, an analyst at Lazard. If Pressler waits too long, he could find himself fixing a fraying company once again.

By Louise Lee in San Mateo, Calif.

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