Urban Outfitters, Fashion Victim

The chain misjudged customers' tastes. Can it recalibrate its edginess detector?

Heather Fauland is your typical Urban Outfitters (URBN ) shopper. Usually clad in jeans and a witty T-shirt, the 21-year-old Tucson college student turns to Urban for the fashion flair that sets her apart from Gap-ified mainstream teens: a flowing skirt, a blue-and-green striped wallet, and, in reference to the month she spent as a vegan in high school, a red tee with a pig that says: "Please Don't Eat Me, I Love You." But since Christmas, she says, Urban has gone from reliably edgy to simply outré. When passing by the Urban Outfitters near the University of Arizona's Tucson campus, she sniffs at the mannequins sporting tight leggings, a tank top worn over a button-down shirt over a sweater with odd cuts and capped sleeves. "I just don't seem to like their kind of edgy right now," says Fauland. "It looks kind of funny."

In the language of hipster retailing, that is a devastating critique. Urban Outfitters' success lies in its ability to pinpoint exactly what kind of edge its hip -- but not too hip -- customers want. And judging by the past few months, the chain badly misjudged its shoppers' sensibilities. Last fall, in its 95 stores worldwide, Urban's buyers proved too quick to embrace new styles. The fashion avant-garde may have been willing to part with distressed jeans and peasant shirts in favor of '80s-style peg-legged pants and baggy V-shaped tops, but Urban's customers balked. (Executives declined comment for this story.)

Seismic shifts in fashion come around maybe twice a decade, and most retailers err by not keeping up. Urban Outfitters was too aggressive, and now its fashion faux pas is starting to hurt the bottom line. Net income had climbed an average annual 44% since 2003, hitting $131 million last year on sales of $1.1 billion. But inventory started to pile up. Philadelphia-based Urban Outfitters Inc., which boasted net margins of nearly 12% last year, was forced to mark down merchandise. As a result, first-quarter earnings plunged 26%. The chain's stock recently skidded to 15.95, a 52-week low.

Compounding Urban's woes was a miscalculation at another of its apparel chains, Anthropologie Inc. (URBN ) Anthropologie's 81 stores target women age 30 to 45 and account for 36% of the company's sales. Last September, Anthro's airy French countryside interiors were punctuated by goth clothes leaning toward the theatrical: high necks, dark colors, odd oversize buttons. When consumers didn't bite, Anthropologie rapidly retooled, stocking October shelves with staples such as basic pants and long-sleeved T-shirts. But by that time consumers had what they needed for the season.

Urban acted fast this spring to clear away excess inventory while simultaneously testing new designs in catalogs. Styles that took off are already making their way into stores, and the clearance area at Urban's Greenwich Village outpost in Manhattan is no longer overflowing with goods. Still, some analysts remain concerned that Urban has gotten too big for its stylish britches. Executives have said they will move ahead with plans to open as many as 38 new stores for Urban Outfitters, Anthropologie, and Free People, Urban's discount concept, which has six locations. JPMorgan Chase & Co. (JPM ) analyst Brian Morgan suggested in a recent report that strong sales in recent years may have masked deeper inventory problems and that the retailer doesn't have the agility to move quickly to scale back inventory.

It all comes back to the vagaries of fashion. In retail "it is hard to be on the top of the heap for a long period of time," says Mary Brett Whitfield, a senior vice-president at research firm Retail Forward Inc. in Columbus, Ohio. "What's hot one moment can easily be not [the next]." The back-to-school season, which starts in late July, will be a critical test for Urban. The company will need to make smarter bets about style, helping its shoppers stay one step ahead of their peers without going too far. In other words, be in fashion, but don't be ahead of fashion. Be different, but don't be too different. Sounds a lot like high school.

By Jessi Hempel, with Danna Cook in New York

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