How H&M's Coping With Retail Travails

A German tax hike and more competition have dimmed the cheap-chic retailer's outlook, but stores in Asia plus a new, upscale chain may help

H&M may be the king of "fast fashion," but changes in some of its markets are nudging the retailer into a slower lane. The company, facing slackening sales growth, lost its place last year as Europe's largest clothing retailer to Spain's Inditex, parent company of competitor Zara. It may face tougher times ahead as competition grows, and as a result of pressures caused by Germany's raising its value-added tax by three points on Jan. 1, to 19%. Germany accounts for more than a quarter of H&M's total sales.

The jury is still out on how consumers in Germany will react to the added tax burden, but H&M (HMRZF) is already suffering there. Sales in Germany fell by 4% in 2006 as more competitors moved in on H&M's cheap-chic turf. And prices are likely to go up due to the VAT change, further dampening demand. Some 80% of the increase will likely be passed on to consumers, according to a survey of German retailers by the Royal Bank of Scotland. Still, that won't necessarily keep Germans from buying new duds. There is no evidence "that a bust in spending is around the corner," the bank wrote in a December report.

Some market watchers say H&M can prosper in Germany if it sticks to its core strategy of stuffing its outlets with hip clothing coveted by young people and quickly reacting to trends it sees elsewhere. H&M "has a formula," says Kurt Barnard, president of Barnard's Retail Consulting Group. "It's based on the recognition that retailing is essentially theater. There's a stage and it must change continuously to hold the interest of the consumer" (see, 3/27/06, "H&M: It's The Latest Thing—Really"). While rivals may be closing in, switching to the quick turnaround formula may not be easy for retailers accustomed to more leisurely changeovers.

Expansion in Asia

To make up for any potential troubles in Germany, H&M is aggressively expanding elsewhere. The company plans to open stores in China and Hong Kong this year and in Tokyo in fall, 2008. "Japan is an exciting market for H&M, with fashion-conscious consumers with great spending power," Chief Executive Rolf Eriksen said in a statement. "We see great opportunities for expansion in this part of the world."

The company is also moving upscale. It is opening a new chain of stores with higher-end offerings this spring. And it is teaming up with pop singer Madonna to create a new range of clothing and accessories, called "M by Madonna," to be available in all its stores this spring (see, 12/12/06, "H&M Moves Up with Madonna").

Analysts remain cautious; most have had neutral recommendations on H&M stock for months. But the company's share price has been inching up, from $41.68 in early October to $51.28 on Jan. 2. Sales for the first nine months of 2006 rose 11% to $7.2 billion.

The fickleness of fashion has brought down many a clothing store. But, says Barnard, "H&M has managed to turn much of the fashion retailing industry on its ear" by taking advantage of this very quality (see, 5/30/05, "H&M: Bringing Haute to the Hoi Polloi"). Whether it can withstand the challenge of rivals that are following in its footsteps remains to be seen.

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