How the apparel industry can ADAPT to inflation
Courtesy of McKinsey & Company
By Jad Hamdan, Claus Heintzeler, Jesse Nading, and Emily Reasor

Key takeaways

·       Apparel companies are getting squeezed between rising supply chain costs and falling consumer confidence.

·       To cope with inflationary pressures and protect their margins, brands and retailers may need an approach that includes action on pricing, merchandising, and supply chains.

·       The ADAPT model offers a five-component approach to reset margin structures with bold, deliberate actions that could yield competitive advantages in a persistently inflationary environment.

As we head into the second half of 2022, apparel firms are getting clobbered. Industry leaders see higher-than-expected operational costs impacting margins as inflation continues to escalate. Across the sector, what began with a difficult May earnings season has continued with the reality of persistent inflation, a more fragile consumer, and the prospect of more turbulent economic conditions as the Federal Reserve attempts to harness inflation. Prices are rising across the value chain, from commodities to transport to labor and more. In the United States, for example, inflation hit 9.1 percent in July, signaling the largest 12-month increase in more than 40 years.

Historically, price realization in the apparel industry has lagged well behind inflation rates and household income growth. From 2010–19, for instance, US apparel prices rose at a CAGR of just 0.4 percent, lagging both the total consumer price index (CPI; CAGR 1.8 percent) and median household income (CAGR 3.8 percent) (Exhibit 1). That gap has recently narrowed, but in the United States, price gains are still trailing CPI growth by about one percentage point (Exhibit 2).

In this environment, apparel retailers and brands are getting squeezed. Not only do they face rising costs on everything from manufacturing inputs and freight to fuel and wages, but they must also deal with a slowing growth environment and falling consumer confidence. Indeed, the percentage of consumers who reported feeling optimistic in our May Consumer Pulse survey fell to 38 percent, from 44 percent in October 2021. The drop in optimism was sharpest among high-income consumers; consumer confidence also fell sharply in the eurozone during the latter half of 2021 and the first months of 2022 as inflation heated up.

Now we see consumers starting to adopt more value-conscious shopping behaviors. The Consumer Pulse survey found that more US consumers reported switching brands and retailers in 2022 than at any time since the pandemic began, and most of them say they intend to keep switching, primarily to find lower prices. Among those who switched, slightly more than one-third opted to buy private-label products.

To cope with inflationary pressures and changing consumer purchasing behaviors, apparel brands and retailers may benefit from comprehensive action on pricing, merchandising, and supply chains. Even as they seek to protect their margins, apparel companies may have to act surgically to avoid alienating customers who are already contending with recent price increases. In our survey, more than three-quarters of respondents said they had noticed prices going up, including in the apparel and fashion industries.

Some apparel companies could consider passing on their costs to consumers, either through higher ticket prices or fewer promotions. But given the discretionary nature of the apparel sector and the potential for long production cycles, others have tried to absorb higher costs while holding the line on prices and promotions to win or retain near-term market share.

Meanwhile, in the face of a global supply-chain shock, upstart brands have been disrupting the known paradigms of fast fashion and apparel retailing. Companies like Shein are rapidly growing to own the Gen Z and “masstige” (mass-produced goods marketed as luxe) consumer bases. Accordingly, established brands and retailers can balance the need to preserve margins and mitigate inflation without pricing out their growing core-consumer segments.

Apparel brands and retailers may be best served by a holistic approach that aims to both protect margins and drive value for consumers. In this article we detail how apparel retailers can use the Five ways to ADAPT pricing to inflation to reduce the risks associated with inflation and best position themselves for long-term success.

ADAPTing to inflation in apparel

There are five components to the ADAPT model: Adjust, Develop, Accelerate, Plan, and Track.

1. Adjust discounting and promotions

Reticketing can be an operationally intensive process for apparel enterprises in an already tight labor environment. In the near term, retailers can escape margin pressures by pulling back on promotions. In recent months, companies such as Victoria’s Secret, PVH, and American Eagle Outfitters have announced that they would cut back on promotional pricing.

Putting this into practice can take many forms. One might be a broad pullback on promotions across the product assortment. Faced with shrinking margins due to inflation, a North American retailer that has historically relied heavily on promotional pricing and deep discounts decided to discount half as often and reduce promotional depth. This approach helped the retailer preserve customer perceptions of value while sustaining its margins.

Since inventories and supply chains continue to be stretched, apparel companies can also protect margins by limiting the use of clearance pricing. By transitioning to leaner inventories, retailers can reduce the problem of seasonal inventory overhang, using fewer promotions and markdowns to clear space for incoming merchandise. The French luxury group Kering reallocated part of its inventory across regions, shipping from European stores to Asia, for example, and postponed deliveries of its spring/ summer collection to prolong the full-price selling period and avoid relying on promotions.

For now, lean inventories across the industry seem like a distant prospect, with June 2022 inventories up sharply year-over-year for many retailers, including Express (40 percent) and Urban Outfitters (32 percent). Apparel retailers and brands may have to find a balance between clearing inventories and pulling back on promotions. They could be more granular about how they promote their entire product assortment, forging a stronger connection between promotional depth and current inventories. It may be easier for vertically integrated and independent apparel companies to combat inflation across the entire buying and product merchandising cycle, since changing product assortments, reconfiguring supply chains, and reducing promotions are all more challenging for pure retailers.

But retailers have ways to cope with inflationary pressures without increasing product prices. For instance, they could increase the minimum basket threshold for free shipping from $50 to $75 to maintain the margin for small baskets without raising product prices. Even more simply, retailers and brands could offer alternative omnichannel fulfillment options, such as buy online, pick up in-store (BOPIS), to reduce costs. Of course, they should test-market such actions in advance to see how consumers will respond.

2. Develop the art and science of price change

Instead of applying an average price increase across their entire product mix, apparel retailers can take a more granular approach to better match prices with consumers’ value perceptions. This gives them an opportunity to reset the value mix across their product assortments.

To counter high costs and inflationary pressure, a granular pricing strategy should account for various customer and product sensitivities, exposures to inflation, and inventory positions. From a category perspective, it calls for segmenting based on price elasticity and margin dynamics.

Raising the price across the assortment while leaning on personalized promotions and loyalty tactics could be the best option, especially for products that are highly exposed to inflation and most important to customers. This approach can strengthen the relationship with high-value customers while alleviating some margin pressures by decreasing the frequency of mass promos.

Segmentation of the product assortment will have to be done repeatedly, since the response of customers and categories to inflation will change over time. Continuous monitoring can help retailers determine the categories and products that face the greatest margin pressures and which customers are likely to be sensitive to pricing changes. Customer research plays a key role in giving retailers the behavioral intelligence they need to understand how customers respond to various strategies. Brands and retailers could increase sell-through by researching what collaborations or new product releases would drive the most engagement, emphasizing scarcity and exclusivity in categories and products that are likely to generate the most excitement among consumers. Companies can also use such insights to refine their market segmentation strategies and personalize promotional pricing in ways that preserve brand value and retain loyalty.

By knowing which categories face the most inflationary pressures and are most important to customers, retailers can make informed decisions on where to hold prices to protect brand value and market share, and where to raise them to protect their aggregate margins. The data are already available. For example, as shown in Exhibit 2, men’s suits currently have four times the price inflation of women’s suits. Such insights are valuable for redefining short-term pricing strategy, which can buy time to test long-term margin-protection approaches.

3. Accelerate decision-making tenfold

This is an ideal time for apparel retailers to remove bottlenecks and streamline processes with vendors, supply teams, design, or store and e-commerce operations. Tactically, this could mean improving visibility into their cost structure, then strategically communicating this information across the organization, potentially even to vendors.

By accelerating decision making, apparel companies can focus their store labor on pricing activities that deliver the highest return on investment, especially when executing quick pricing actions in response to price changes made by competitors.

For example, apparel retailers could fast-track in-store pricing execution to enable faster planogram changes and pricing updates, thus reducing the lag time between the decision to make price changes and their actual implementation in stores. For retailers with heavy digital penetration—especially those whose site merchandising is mature—rolling out pricing or promotional changes online could be a fast, low-cost way to execute change at scale. European fast-fashion retailers H&M and Zara have taken this approach, expanding their online channels to complement their physical stores, generate growth, and offset inflationary costs. In 2021, for example, Zara invested in in-store pickup, in-store product click-and-find, 30-minute online buy, and product tagging using radio-frequency identification.

To read the full article, please visit https://www.mckinsey.com/capabilities/growth-marketing-and-sales/our-insights/how-the-apparel-industry-can-adapt-to-inflation

About the author(s)

Jad Hamdan is a consultant in McKinsey’s Chicago office, Claus Heintzeler is a partner in the Berlin office, and Jesse Nading is an associate partner in the Denver office, where Emily Reasor is a senior partner.

The authors wish to thank Pamela Brown, Becca Coggins, Sandrine Devillard, Andres Monge, and Gereon Sommer for their contributions to this article.