Innovation Is Slowing and There's No Breakout Product: Uniqlo Should Be Worried | Top 15 Annual Report

What happened to the idea that "Uniqlo isn't really a clothing maker but a technology company"? If Uniqlo's dry spell in product innovation drags on too long, the downward chain reaction could come far faster than anyone imagines.

On January 6, the share price of Uniqlo's parent company, Fast Retailing, plunged from ¥42,590 to ¥39,720 — a steep 6.7% drop. Founder and chairman Tadashi Yanai watched his personal fortune shrink by $1.4 billion in a single day, sliding from 6th to 44th on the Bloomberg Billionaires Index.

The culprit was the December Japan sales data Uniqlo released on January 5. That month, Uniqlo's Japan sales fell 5% year on year, and same-store sales dropped 5.9%. The company blamed the weak numbers on "unusually warm weather," which sapped demand for winter products.

If only the problem were that simple.

Uniqlo's troubles are already serious. In the 2015/2016 fiscal year that just ended, Fast Retailing posted its slowest growth in three years — revenue rose just 6.2%, far below the 21% annual pace of the two years before. Worse, the company has little confidence in the road ahead.

Alongside the earnings release, Fast Retailing cut the "2020 Plan" it had set in 2012. The original target called for ¥5 trillion in annual sales by 2020. The revised figure is ¥3 trillion — a 40% haircut.

This is essentially an admission that both the multi-brand strategy and the American market have failed. Fast Retailing had counted on both to drive group growth. But in 2015/2016, brands including J Brand and Princesse tam.tam kept bleeding money; GU, the in-house brand launched in 2006, grew sales more than 30% but is too small to move the needle for the group. As for the U.S. market, which Uniqlo entered back in 2005, the losses are only widening.

Uniqlo is still by far Fast Retailing's most important brand, contributing more than 80% of group sales. So in a real sense, Fast Retailing's problems are Uniqlo's problems.

And Uniqlo's problems go beyond the still-elusive American market. The more pressing trouble is closer to home: Japan and Greater China together account for 63.4% of Uniqlo's sales.

In Japan, Uniqlo's sales grew just 2.5% over the past year — about a quarter of the prior year's rate — and operating profit swung from 10.3% growth to a 12.6% decline. In Greater China, operating profit fell 5.5% year on year, the first profit drop since the company began reporting Greater China results separately in fiscal 2012/2013; revenue growth slowed to 9.3%.

In China, Uniqlo has not seen growth this slow — let alone an outright decline — in a long time. Remember that in fiscal 2013/2014 and 2014/2015, Greater China revenue grew 66.5% and 46.3%, while operating profit surged 83% and 66.1%.

You may find Uniqlo's current predicament hard to believe. After all, the brand's recent image in China has been one of frenzied Double Eleven sellouts — it topped Tmall's Singles' Day apparel rankings two years running. But that sales pop came from deep discounts. Over the past year, Uniqlo has been marking down, cutting prices, and running promotions more often — not just on Tmall and not just on Singles' Day, but in its physical stores too.

And that points straight to the problem. For any brand, discounting is a perfectly ordinary tool. But discounting too often is dangerous: it signals that inventory has piled up to unhealthy levels. For Uniqlo China, that inventory glut has already cost it a 5.5% drop in operating profit.

A few years ago, none of this was imaginable. Some outside factors are unavoidable — competition has intensified, for one — but markets are always competitive. So why could Uniqlo grow fast and healthily in the past, only to stumble now?

It's worth looking at how it built its glory days.

Tadashi Yanai once told Wired something that has since become shorthand for Uniqlo's edge: "Uniqlo is not really a clothing manufacturer. It's a technology company. Our competitor is Apple, not Gap."

The Boston Consulting Group's "50 Most Innovative Companies 2015" list reinforced the point. Fast Retailing ranked 15th — the only apparel retailer to make the cut — beside 3M, Amazon, Apple, GE, and Google.

And it's true: Uniqlo's fast growth in recent years was indeed driven by technological innovation. In Yanai's view, applying technology to everyday clothing creates differentiation and adds real value.

In 1998, Uniqlo launched its fleece line. The fabric was not Uniqlo's invention — until then, fleece had been largely monopolized by foreign makers, and a fleece jacket in Japan retailed for around ¥5,900. By partnering with Japanese textile maker Toray, Uniqlo could produce and sell fleece garments at roughly half the market price. That year, fleece sold 8.5 million units in Japan — well above the original target of 2.5 million. By 2000, Uniqlo had sold a fleece top to nearly one in three Japanese people.

In the process, Uniqlo created one of the greatest sales phenomena in Japanese apparel history — and vaulted to become Japan's largest clothing retailer, a spot it still holds today.

In 2003, Uniqlo launched its HeatTech line, bringing it to China in 2008. This fabric, too, was not wholly original — similar materials had been used for sports underwear before, sold only in sporting goods stores. The Toray partnership let Uniqlo break through the technology barrier and bring the heat-retaining fabric to a far broader mass market at a lower price. By 2011, HeatTech had sold more than 300 million units worldwide.

In 2006, Uniqlo formalized a strategic partnership with Toray, with both companies seconding staff to form a joint "next-generation materials development team" focused on new fabrics.

Three years later, in 2009, Uniqlo's Ultra Light Down jacket went on sale in China. You may still remember how it took the market by storm. Beyond the new material, Uniqlo added an innovation in form: the jacket — said to weigh just 206 grams — could fold down into a compact triangular pouch and travel easily. At a time when the market was awash in bulky, unwieldy down coats, Uniqlo's Ultra Light Down was a genuine surprise.

The pattern is clear: Uniqlo's path to commercializing technology has always run through cutting costs, which in turn lowers prices and opens a new mass market.

But since the Ultra Light Down, Uniqlo has not produced a technology-driven hit of that caliber. This is not to say its R&D has weakened. Uniqlo has kept launching new fabrics and technologies — including the quick-dry line for summer in 2008, and the Silky Dry and Sarafine lines for men and women in 2010 (later merged into AIRism in 2013). But none of these drew a strong response from consumers.

Uniqlo's product-innovation engine is losing power — or at least losing speed. Athleisure is a telling example. The trend took off around 2014 — a category that, by its nature, makes higher demands on fabric technology. Uniqlo largely ignored it at the time. Not until November 2016 did it formally unveil its "Uniqlo Sports" athletic line, at the 2017 Spring/Summer Tokyo presentation, along with a new wind-resistant fabric called Blocktech. But by then athleisure had been rolling for two years, and Uniqlo had missed its best window.

For Uniqlo, making a technology blockbuster is not just about selling more garments. It is also about claiming authority in the industry. Technological innovation and application are, at heart, a way of meeting — or even creating — new demand. Uniqlo's fleece and HeatTech brought technologies that were once costly and scarce within reach of ordinary consumers; the Ultra Light Down went further and created an entirely new market segment. Before it caught on, most down coats were bulky and impossible to pack away.

And the markets it opened have since been overrun by imitators. Fleece is everywhere. On Taobao, countless brands sell what they call "heat-retaining thermal underwear." The Ultra Light Down, too, has become standard fare for Bosideng, for dozens of department-store labels including Only, and for various sportswear brands.

The more damaging consequence is this: technology-driven products are not just a direct source of revenue — they are concept-makers, conversation-starters, marketing accelerants. They once drew curious young consumers into stores to see what the fuss was about, and in doing so drove sales of other items too — T-shirts, shirts, and the like.

With the technology pipeline running dry, Uniqlo has tried new tactics over the past two years to spur spending — most notably, designer collaborations. But apart from the two Uniqlo x Lemaire collections in 2015 and 2016 (the work of former Hermès creative director Christophe Lemaire), most of these joint lines have fallen flat.

Asked about the designer collaborations, one Shanghai consumer said, "They're sitting in the stores on markdown and still not moving." He used to visit Uniqlo about once a month, he said, but has been going less often lately. "I feel like I've already bought everything I need. Now I only go in when there's a collab."

That feeling — "I've already bought everything I need" — is not an isolated one. Another consumer we met at Uniqlo's Huaihai Road flagship told QDaily she had started visiting Uniqlo regularly in 2011 and, over the next three years, had amassed "twenty or thirty" Uniqlo pieces. But now she, too, only goes in for collaboration launches. Her complaint about the collabs: "They were 40 percent off after just a few months. I was heartbroken." Her visit to the Huaihai Road store that day was to "learn from the discount lesson" and try her luck at finding a Uniqlo x Lemaire piece still at full price.

Uniqlo's most recent collaboration launch also misfired in China. In June 2016, Uniqlo announced a new line called Uniqlo U, with Christophe Lemaire as artistic director. But three months after launch, the line was already on sale. On the secondhand platform Xianyu, many pieces from the collection were being resold below retail — one item listed as "brand-new Uniqlo U, tags attached," a V-neck wool cardigan, was going for less than its original price of 219 yuan. By contrast, H&M's Balmain collaboration, originally priced at $499, was bid up to $1,200 on eBay.

Not every collaboration has flopped. According to Wu Pinhui, CMO of Uniqlo Greater China, in an earlier interview with QDaily, the collaboration between Uniqlo's UT line and graffiti artist Kaws sold "one million units" in China within a few months of its April 2016 launch. At ¥99 a piece, that works out to roughly 100 million yuan in sales for Uniqlo China. But trend-IP collaborations like Kaws target a consumer who doesn't fully overlap with Uniqlo's core base, and turning those buyers into regular Uniqlo shoppers is no easy task.

It's worth noting that even with Uniqlo China's slowing growth and underperforming collaborations, it remains the best-performing fast-fashion brand in China. In fiscal 2015, H&M's China sales were about $1.2 billion (less than half of Uniqlo's), with 383 mainland stores as of the end of last November (Uniqlo had 500). Zara has not disclosed its China sales and had 189 mainland stores as of last October. Zara had also said in 2015 that it would slow its store openings in China.

But the competition's expansion is gathering momentum too. In fiscal 2016, H&M opened 80 new stores in China — close to Uniqlo's 85. H&M has also said "future store expansion will focus mainly on China and the United States." Meanwhile, Korean fast-fashion brand 8seconds formally entered China in 2016, and British fast-fashion label New Look has announced plans to open 500 stores in China.

All of this places Uniqlo in an ever more complex and competitive environment. And the fiercer the environment, the more vital the things that set the brand apart in the first place — innovation, technology, and value for money.

In Japan, the erosion of those differentiators has let competitors close the gap, and in a weak economy, cheaper products are finding a ready market. We have written before about Shimamura, a prime example of this dynamic: a clothing company that makes no claim to quality and runs on a pure buy-low, sell-low model, it holds the number-two spot in Japan's apparel retail market on the strength of prices even lower than Uniqlo's. In the first half of last year, its net income grew 46%; for the full year, operating profit rose 15.8% year on year — far outpacing Fast Retailing's –12.6%.

As technology and product innovation slow and no new demand is being stirred, another problem follows: market saturation. That is, once a consumer already owns one Ultra Light Down jacket, or two, why would they need a third? This is exactly what the people we spoke to meant by "I feel like I've already bought everything I need."

Over the past year, Uniqlo has failed to bring out any new product that could surprise consumers or set the market alight.

In tier-one cities, Uniqlo is also starting to see its customer base age. More and more middle-aged and older shoppers are turning up in its stores. A glance at the Uniqlo Tmall flagship confirms the trend — comments like "buying for my parents" and "my mom loves it" are anything but rare. According to an FT market study, Uniqlo's popularity in tier-one Chinese cities has been slipping slightly.

Uniqlo seems to have sensed the problem. In November 2016, it released six short dialect videos, rapping about its featured winter down products in Cantonese, Shandong dialect, Shanghainese, Hokkien, Sichuan dialect, and northeastern Mandarin. According to the Uniqlo executive in charge of the campaign at the time, "speaking dialect is a cool thing," and the company believed that "this generation of young people prizes local culture, a sense of urban belonging, identity labels, and a distinctive swagger that adds up to a unique kind of cool."

But a few videos alone are unlikely to make a brand "cool" — especially since "cool" has never been part of Uniqlo's DNA. Innovation, technology, and value for money are what draw young people to the brand, and they are also why Uniqlo can be unfashionable and still outsell H&M and Zara.

Uniqlo now plans to expand in China at 80 to 100 new stores a year. As Pan Ning, CEO of Uniqlo Greater China, told the South China Morning Post in an earlier interview, "Given the purchasing power of second- and third-tier cities, these markets are well worth developing."

This is how Uniqlo is hunting for new growth. In markets it has yet to fully penetrate, HeatTech, AIRism, and Ultra Light Down may still have real room to run — but the window won't stay open forever. Living off old successes is always a risky strategy.

One piece of news that may count as good for Uniqlo: the same Financial Times study found that Uniqlo's popularity in China's second- and third-tier cities grew sharply over the past year.

But second- and third-tier markets have their own complications. These are markets where domestic brands are far stronger, and the formula for survival — franchise-based distribution to cast a wide retail net, paired with loud marketing — is how brands like Metersbonwe, Semir, and Heilan Home have secured their footholds. Whether Uniqlo can adapt to that kind of market is an open question.

By the end of 2016, in its fourteenth year in China, Uniqlo had opened 500 stores across more than 100 Chinese cities. But as Tadashi Yanai himself put it, "Uniqlo in China is only just getting started." The ultimate goal is 1,000 stores in China — more than Uniqlo's current count in Japan.

That is an ambitious target. But what Uniqlo should guard against is this: the fiercer the competition, the more the things that set the brand apart matter. Lose sight of that, and it risks becoming ordinary.

Innovation is always the most powerful engine of growth. If Uniqlo's dry spell drags on too long, the downward chain reaction could come far faster than anyone imagines.

About the Top 15 Annual Report

2016 was a turbulent year worldwide. In business terms, the market leaders suffered more than their challengers.

The 15 companies QDaily tracks as leaders in lifestyle change had a rough year, and they all shared one problem: the ceiling.

Whether developing new products (like Apple's watch and car ambitions), new customers, or new channels (like IKEA moving into e-commerce), these industry front-runners are all urgently — and perhaps blindly — searching for their "next" growth engine.

Breaking through that ceiling has proved harder than expected. The QDaily Top 15 year-end report for 2016 is not all good news.

Cover image from Fast Retailing's official website