For fashion players, 2019 will be a year of awakening. The ones who will succeed will have to come to terms with the fact that in the new paradigm that is taking shape around them, some of the old rules simply don’t work. According to McKinsey Fashion Scope, Greater China is expected to overtake the US as the largest fashion market in the world in 2019. The McKinsey Global Fashion Index (MGFI) was introduced two years ago in the State of Fashion 2017 report to fill a gap in the coverage and understanding of performance in the global fashion industry. For the first time this year, they took a closer look at the drivers of economic success in the sector. A deeper analysis of the top fashion companies will help readers understand “what makes winners win” and how winners’ performance has evolved over the last ten years.
The rise of the ‘super winners’:
The good news for the industry is that 2017 was a record-breaking year for overall value creation among listed fashion companies, with aggregate economic profit reaching its highest levels for 10 years, after a steady decline between 2012 and 2016. This was driven by a particularly strong upswing in revenue growth for publicly listed companies, resulting in improvements in capital efficiency as invested capital grew at a slower pace than revenues. Investors recognized this strong performance, driving share valuations to an all-time high. And this was not just part of an overall stock market trend: between 2008 and 2017, fashion sector equity returns have beaten both the S&P 500 and MSCI world indices.
In past editions of this report that fashion is a winner-takes-all industry. However, after a period of accelerating out performance, leaders in 2017 gave up some of their advantage. The top 20 percent of companies attracted 128 percent of economic profit in 2017, compared with 144 percent in 2016. Still, polarization has clearly not gone away and scale continues to matter. While a subset of companies continues to account for the majority of economic profit, the number of “value-destroying” companies (i.e., companies generating negative economic profit) has almost doubled between 2010 and 2017.
This polarization has led to an even smaller group of “super winners.” In fact, over the long term taking the top 20 companies as a sub-group, there was a widening disparity with the remaining companies encompassed in the top 20 percent. These “super winners” now account for 97 percent of economic profit, compared with 70 percent in 2010: this suggests they are increasingly dominating the global value pool. This is a global phenomenon that can be observed across industry sectors (beyond fashion), regions and cities, as outlined in McKinsey Global Institute’s recent “Superstars” study.
By segment, we also continue to see polarization, with luxury and value advancing and mid-market players falling behind. Companies able to differentiate on price point/efficiency or brand have performed best. Outstanding performers included handbag and luggage makers and own-brand multi-category players. Well-known European luxury companies tended to be over represented in the top 20, with North American companies coming in a close second. Notably, the top 20 group of companies has remained stable over time. Twelve of the top 20 have been a member of the group for the last decade. Long-term leaders include, among others, Nike, LVMH and Inditex, which have more than doubled their economic profit over the past ten years — according to MGFI estimates each racked up more than $2 billion in economic profit in 2017. The most resilient winners included luxury, sportswear and fast fashion players, reinforcing the point that brand investment and operational efficiency are key drivers of sustainable business models. Over time North American department stores lost out, with none remaining in the top 20, compared with three 10 years ago — a stark illustration of the fragility of the traditional retailing model. Notably, online players have yet to break into the elite group, with only two players in the top 20 percent and none in the absolute top 20. Their average top-line growth is four times higher than that of other fashion players, but this tends to translate only into valuation multiples (twice as high as average) while profitability still lags behind.
Looking at drivers of long-term success, we find that profitability and capital efficiency are key: winners all had above-average EBITDA margins and most exhibited below-average invested-capital-to-revenue ratios, while the percentage of revenue growth was in line with the wider sample.
Sunny intervals but storms ahead:
Looking ahead to 2019, we see many opportunities for the fashion industry — but also many risks. The latter emanate mainly from the evolving macroeconomic environment and the potential for disruption from shifting trading relationships (see trend articles on. It is useful to view the industry’s potential future through four separate lenses, each of which offer a perspective on the most important drivers of growth and key topics covered in this report. The lenses are industry and regional performance, market segment performance, product category performance and overall operating profit performance.
Industry and regional performance:
We predict industry growth of 3.5 to 4.5 percent in 2019, slightly below our 4 to 5 percent estimate for 2018, when the industry was bouncing back from a relatively weak period. Continuing the trend of recent years, players in emerging Asia Pacific and emerging Europe will lead the way; however, emerging Asia Pacific is likely to continue its strong performance in 2019, while emerging Europe will probably slow slightly from 2018. Mature Europe and North America will also see slightly slower growth. The overall impact will be slightly less robust global industry growth than in 2018. We see Latin America (in particular Brazil), Middle East and Africa and Russia experiencing more economic and political challenges that are likely to dampen their consumer spending.
Value segment performance:
As in previous years, we expect the best-performing segments in 2019 to be luxury, fuelled by fast-growing Asia Pacific economies and the continuing boom in global travel, and value, fuelled by strong propositions globally. Prospects for affordable luxury are likely to be more fragmented, with some regions expecting above-average growth (e.g., emerging and mature Europe and China), while others such as Japan, Latin America and North America underperform. Premium/bridge and mid-market players are most likely to struggle, in the face of strong competition from value/ discount players and increasing market saturation.
Product category performance:
Similar to last year, we expect sportswear to continue its recent winning performance, boosted by strong demand from younger cohorts. Handbags and luggage are also likely to see strong growth, reflecting a global tourism boom that shows no sign of slowing. Jewelry and watches, on the other hand, may struggle in many markets as rental models start to replace traditional sales. In apparel, the rising sustainability movement may be a slowing factor in some markets, but the impact will probably be offset by growth in emerging markets.
Operating profit performance:
We expect margins in aggregate to remain steady through 2019, despite caution among industry players. Some 67 percent of respondents in the BoF-McKinsey State of Fashion survey are concerned that margins will decline. Reasons cited include the broad-based move from offline to online channels, where margins tend to be thinner and distribution costs are higher, partly driven by high returns. Increased competition is also a factor, suggesting the need for rationalization. Further, rising transparency may increase the pressure on prices, and there is limited room for further cost cutting following recent initiatives. On the other hand, there are several levers players are using to improve profitability, including efficiency drives, use of analytics to relieve markdown pressure and automation enabling faster speed to market.