Can Gap’s Price Optimization Strategy Improve Profitability?

As Gap Inc strives to improve sales, it faces stiff competition from fast fashion retailers. The company now uses a cloud-based optimization system to track the price of inventory in its network of retail stores. The new strategy will allow Gap to optimize prices in several ways, including identifying the location of distribution centers closest to stores in order to minimize costs. It also offers localized promotion policies and also has an elastic pricing solution. Gap faces a continued decline in earnings and its stock price fell after the April sales results were released. We recently lowered our price estimate for the company by 30% due to low revenues. While a price optimization strategy will be to the advantage of the company, it must work on its products to make them more attractive to consumers, in order to improve sales and to compete with fast fashion retailers.

See our full analysis for Gap Inc.

Use of data for complex modeling to optimize prices

Gap tries to use its extensive data spread across various databases to solve a compute-intensive problem using a linear optimization tool called Gurobi. Using this technology, Gap plans to reduce the cost of moving inventory to its thousands of stores from distribution centers by finding the most profitable match. Other areas where this optimization technique can help include managing promotions and eliminating slow moving inventory. If a particular inventory item does not sell in one or more locations, Gap can now price the product lower in that region instead of giving a flat rate discount on it in all locations. Regional and seasonal factors (i.e. summer short sleeve products) can also be factored into the model to optimize the price for each location. As it stands, Gap engages in huge clearance sales when faced with slow-moving inventory issues, often resulting in high losses. The new optimization strategy can solve this problem by localizing the discounts, thus improving profitability. Another challenge that Gap faces is the inability to get new inventory to stores more often, which can be addressed with a shorter production run. However, by reducing the transportation costs to move inventory from distribution centers to stores, Gap can move inventory more frequently at a lower cost. Including a shorter production cycle with faster rotations, this optimization can have a positive impact on profitability.

We expect the Gap stores EBITDA margin to decline steadily from around 21% in 2016 to around 19% by the end of our forecast period.

If through its pricing strategy, Gap can stop this decline and maintain an EBITDA margin of 21%, there may be a 10% increase in our price estimate.

Gap faces serious challenges and the company must innovate to re-attract customers to its brand. While the price optimization strategy should help reduce costs and improve margins, a better product strategy will be essential to increase revenue.

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