Creating value in fashion: How to make the dream come true

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What sector has outperformed the overall market and every other sector across geographies for more than a decade? Many are surprised to learn that the answer is the apparel, fashion, and luxury sector. From 2003 through 2013, this sector led the market in performance, outstripping even high-growth sectors like technology and telecommunications (exhibit 1). While performance declined in 2008 due to the economic crisis, the sector rebounded quickly, delivering higher total return to shareholders (TRS) than ever before at an increasingly faster pace than other industries.

Exhibit 1
Exhibit 1

Profile of outperformance

This pattern is global. Across geographies, publicly traded apparel, fashion, and luxury companies have outperformed the overall market index by five to eight percentage points annually since 2003, increasing their share of global retail sales from 12 percent in 2003 to 17 percent in 2013 (exhibit 2).

Private companies, which dominate share with 83 percent of global revenues, show the same kind of financial muscle. Using the Forbes list of billionaires as a proxy for personal wealth creation shows that the more than 200 billionaires in the fashion and retail sector included on the list hold 15 percent of the total Forbes net worth of $6.6 trillion, outpacing the often-acknowledged wealth-creating sectors of technology (11 percent), finance (5 percent), and sports (1 percent).

Exhibit 2
Exhibit 2

Formula for creating value

Of course, not everyone in the fashion industry is thriving. More than 25 percent of industry players destroyed shareholder value from 2003 to 2013, making the fashion industry a sector far from a uniform success.

But the winning players—the almost 20 percent that have delivered more than 20 percent TRS per year over the decade—share a formula for creating value. According to McKinsey’s research, 50 percent of the value these companies create comes from achieving superior performance and 50 percent from managing perceptions. Perhaps not surprisingly, perception drives more value creation in the apparel, fashion, and luxury sector than in almost any other industry.

Performance. When it comes to performance, winning companies  make good decisions in strategy (where to play) and execute flawlessly (how to win), with a particular focus on sales growth, which accounted for 12 percent of their TRS. Although companies relied more heavily on sales growth than margin improvement to drive value, both strategy and execution were important for companies to successfully drive sustained value over time.

Company size does not affect the ability to execute this value-creation strategy successfully. Large and small companies generated comparable returns (16 percent TRS per year). In fact, these companies exhibit alternating periods of growth acceleration and margin improvement to drive the next burst of value.

An important element of the strategy is having a portfolio—particularly a diverse one—of brands.. Companies with a diverse portfolio created 14 percent more value than companies with a single brand. Companies present in multiple product categories created 33 percent more value than companies operating in a single category. Companies that predominantly focused on retail distribution or had a healthy mix of both retail and wholesale (less than 2/3 of sales concentrated in either retail or wholesale) created 45 percent more value than companies with a predominantly wholesale model. Most importantly, companies that rang up a large portion of their sales abroad created 167 percent more value than companies that didn’t.

M&A activity also has meaningful impact. Companies that completed many M&A deals (seven or more since 2003) generated 25 percent more value than those that did fewer deals. Most of the transactions focused on international expansion, vertical integration, or portfolio expansion. In essence, the winners used acquisitions to realize the benefits of portfolio diversification.

Perception. People’s expectations of a brand constitutes an intangible but critical source of value. Perception ultimately comes down to the market’s sense of a brand’s growth potential balanced against an assessment of its risk profile.

Perception has two dimensions—brand fundamentals and the narrative. The fundamentals provide the foundation for building and maintaining growth momentum—brand health, intellectual property, talent, and the leading-edge capabilities in areas like design, merchandising, digital, and M&A. These elements provide the company’s creative engine. Sustainable growth requires managing this momentum in a measured and disciplined way so that overexposure does not destroy long-term brand equity for the sake of short-term profits. Winners anchor growth management in a strategic roadmap with precise guidelines and activities to achieve their aspirations and create value, and they invest in building the brand, managing talent, and increasing managerial discipline.

The other dimension of perception is the narrative, or the company’s story. Fashion companies show and tell this story in every runway show, window, and floor display. The narrative includes the value that the brand communicates and supporting messages conveyed to investors, partners, the media, employees, and customers. The narrative forges the emotional connection that brands need to sustain loyalty and growth.

The fashion sector has tremendous value at stake. Striking the right balance between delivering performance and managing perception should sustain the sector’s long-term outperformance and ensure that value creation always stays in fashion.