Is Lululemon Bending Over Backwards for Wall Street More Than Customers?

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Lululemon Athletica revealed Monday that it expects earnings to drop this quarter due to a dud batch of its popular yoga pants made with its proprietary luon fabric, which its store managers indicated were being returned by customers who found them too sheer for wearing. “Some of our bottoms were made with a batch of black luon that doesn’t meet our standards so we’ve pulled them from our floors and our website.” 

After being downgraded by Credit Suisse and others after the news, an earnings call today meant to detail the company’s fourth quarter and full year 2012 results along with 2013 developments such as a move into golf and tennis apparel was instead taken up with answering analysts’ questions about how it was handling the crisis—and offering more (ahem) transparency about the situation than has been offered to customers.[more]

Lululemon CEO Christine Day told analysts that the situation, which is still being investigated, has “devastated” employees. She spoke of an internal push to develop an early warning system, codenamed Project Canary, to identify and deal with quality issues sooner. “The whole organization is obviously very devastated by what’s happened,” she said. “And so everybody understands the sense of urgency of making sure that we alert the small noise and symptoms that we see, the little canary chirps, getting those to us as quickly as possible so that we can deploy the resources to avoid anything like this again.”

CFO John Currie outlined the expected financial impact on the company, with a projected write-down for the affected goods (about 17 percent of its inventory globally) and related costs estimated to hit a loss of about $60 million, based on projected “lost revenue of $12 million to $17 million in the first quarter, and additional lost revenue of $45 million to $50 million for the balance of the year, primarily in the second quarter, spread over new and existing stores and ecommerce.”

The full extent of the financial hit is unknown because it’s hard to estimate how many pants will be returned for refunds, and containers of potentially compromised clothing are still in transit, adding “We’ve also assumed that product which is still in the factories or under production for the summer season is similarly impacted and therefore must be written off without offset by any potential recovery. Although testing is underway, at this time we believe this to be a likely scenario.”

It’s not the first quality episode for the Yoga-centric, cultish and billion-dollar brand, which had a dye issue last summer and has had “other fabrics that occasionally will have issues,” according to CEO Christine Day on the call, who said that the items in question had passed quality assurance tests, but admitted that the company was stepping up its quality control oversight. Brand loyalists, meanwhile, are confused by news of the Canadian-based retailer’s “pullback”—Lululemon speak for “recall”—of black luon yoga pants purchased after March 1, a significant percentage of the retailer’s merchandise.

Beyond a blog post posted to its website on March 18, all while “Lulu addicts” took to social media and in particular its Facebook page, the company remained mum on which exact styles were affected. Concerned customers who suspect they may have an issue with their black luon, form-fitting clothing items puchased after March 1st are being advised to contact the brand’s GEC (Guest Education Center, or customer service center, to the rest of us).

“The company’s see-through black Luon pants is the latest in a series of quality glitches that threatens to alienate the retailer’s hardcore fan base, which has so far been more than willing to shell out $100 for pants and other athletic garments,” notes USA Today. “These legions of followers have helped Lululemon, founded in 1998, become a billion-dollar business.” Calling themselves Lululemon addicts, these brand loyalists typically wear their pricey yoga pants while running errands and dropping off their kids at school, and not just in the yoga studio or gym.

Wall Street’s Lululemon loyalists were also demanding answers. In Thursday’s earnings call with analysts following the company’s stock, CEO Christine Day fielded what seemed like an unending stream of questions concerning the company’s quality control and response to the crisis. 

“The truth of the matter is the only way you can actually test for the issue is to put the pants on and bend over,” admitted Day. “Just putting the pants on themselves doesn’t solve the problem. It passed all of the basic metric tests and the hand-feel is relatively the same (as previous Luon pants), so it was very difficult for the factories to isolate the issue, and it wasn’t until we got in the store and started putting it on people that we could actually see the issue,” she commented in response to an analyst’s question about why the brand didn’t stretch-test clothes intended to be worn bent over in yoga positions such as the rear-exposing downward dog.

In a press release to investors with Thursday’s earnings, Day stated that “the fundamentals of our business are strong,” citing that, “Delivering the top quality our guests expect is a critical factor in our differentiation in the market place. Our proprietary fabric, black Luon, is a very technical and sensitive product to manufacture. We have a long history with our manufacturers and as we have in the past, we are working closely with them to resolve the current issues. We have a team on site collaborating with them to identify the root cause.”

As of press time, the company has not publically informed its “guests”—what Lululemon calls its customers—which specific styles have been affected, instead generally stating that the pullback affects “certain styles concentrated in our tighter fitting silhouettes in women’s black luon bottoms.” Rather than issuing a statement on Twitter or Facebook, community managers such as Somerlea Contreras (se above) are responding to individual queries within the parameters handed down from management, which means directing concerned customers to the GEC.

Day, however, did reveal on the earnings calls more specific information about the styles being pulled from store shelves and the company’s e-commerce site. “It just is particular to the Groove Pant and the Wunder Under, and then a couple of seasonal styles, a couple of crops (midriff-baring crop tops) that match those and a couple of shorts. So there still are Luon (items in stores), there are still printed Luon, and there’s Luon that’s colored. So it’s just the black pant in particular,” she said.

Day also assured the analyst and investors listening in on the earnings call, “We want to just reiterate our commitment to being completely transparent and passing along the information as we learn it, so that you can have confidence and faith in us that you will always be the first to know whenever we have an issue.” Yes, she said “transparent” — and “you” as in the company’s investors and analysts, not customers. Just days earlier, however, Day stated that the “most important relationship is with our communities and our guests.”

The issue shines light on a fault in the brand’s transparency—and not the see-through pants kind. As brand fans react on social media, it’s obvious that many questions have gone unanswered so far. As for Lululemon’s competitors, no one is hesitating to take advantage of the brand’s slip-up. The impending shortage of black yoga pants is sending potential customers to brands including Under Armour, Nike and Gap’s Athleta (expanding from 35 to 65 stores this year, the New York Times reports)—where similar styles are considerably cheaper. 

The missed opportunity to be more upfront and open was highlighted this week by a rival retailer, H&M, which just announced that it will include a full list of suppliers as part of its annual sustainability report, information traditionally not announced but increasingly top of mind, as the brand has taken a stance on supply chain management and worker safety at its factories in Asia.

“We are proud of the achievements we have made during the year. We are transparent about the progress we make and the report is an important part of that. Our customers should feel confident that everything they buy from H&M is designed, manufactured and handled with responsibility for people and the environment,” said H&M CEO Karl-Johan Persson in a press release.

The Canadian-proud Lululemon has come under fire in the past for moving its manufacturing abroad, but defends its outsourced production and supply chain policies on its website, where it points out the importance of factory capabilites and technology as it services a growing number of stores worldwide, with Hong Kong announced today as next on its radar.

“We started with one lululemon store in the Kitsilano neighbourhood of Vancouver BC, in 1998,” its website states. “Our first factory was just a 10 minute drive from the store. Then one store became seven, which eight years later became over seventy-eight stores in four countries and by the end of 2012 will be over 200. With this growth we’ve formed global manufacturing partnerships that support our needs for both capacity and technical capability.”

On Thursday’s earnings call, Day assured analysts that a team is actively working with manufacturers to source the sheerness issue. “We have not yet determined the specific cause for the sheerness, and are pursuing several hypotheses in parallel with our manufacturing partners to determine the root cause.”

“Every company risks suffering from quality-control issues and errors in their supply chain. But when a brand has a following as obsessed as Lululemon’s, the fall off its pedestal is that much farther,” observed Jena McGregor in the Washington Post. “The attention is even greater if one of the very things that prompted customers to flock to the brand — quality, in Lululemon’s case — is what’s suddenly taken a hit.”

Day noted in response to an analyst concerned about quality control issues that she’s been staffing up in that department, noting key recent hires: “Joan (Mudget) comes to us from most recently at J.C. Penney, and she’s worked for Nordstrom before that. So she’s our new director of QA (Quality Assurance). We’ve also made a deep hire in our R&D department, Dr. Tom Waller, who comes from the Speedo group. And so he also works on developing raw materials…We’ve also put a person on the ground in Taiwan, and he’s already been in place, and he’s building a team there that will actually be at the factories where we produce.”

The changes may be too litte, too late for Lululemon, as its share price fell 6.4 percent on Wednesday. As for what the future holds, only time will tell if Lulu fixes its supply chain issues and gains back the trust of its “guests.” In the meantime, though, if anyone would like to help the brand get its groove back (in more ways than one), Lululemon is looking to hire a Director of Global Sourcing.

Below, the 404 error message for the recalled Groove Pants on lululemon.com — 

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