Lululemon lovers buy into healthy lifestyle

• 211 stores worldwide%2C average %245.5 million in sales per store
• Known for yoga apparel%2C brand promotes healthy living%2C communities
• Stores offer free yoga and running clubs

For a relatively small but growing circle of fitness fanatics, glimpses of the Lululemon Athletica brand act as a signal.

Running by someone in a distinctive, neon-striped hoodie or seeing a co-worker bring lunch in the same reusable red shopping bag covered with the company manifesto — "friends are more important than money," "breathe deeply" — are both signs that two people have been initiated into the same tribe, one that worships healthy living, tight-knit communities and colorful athletic apparel.

The company's loyal followers rave like obsessive groupies. "Once you go Lululemon, you never go back," says 24-year-old Nitasha Khetarpal, of Valencia, Calif.

"It is the reason I started exercising again," says Anna Ferguson, 40, who works as a financial officer for a small company in Greensboro, N.C.

"Lululemon products have a way of making you want to work out," says 20-year-old Penn State junior Natalie Handali.

As bricks-and-mortar retailers are still somewhat stumbling their way through the economic recovery and trying to entice shoppers who are increasingly turning to digital channels, Lululemon has barely missed a step on the road to success. It has hit a sweet spot with coupon-crazy and budget-weary consumers, figuring out a way toward consistent, booming success that doesn't involve discounting and draws customers who simply want to hang out in its stores as much as they want to buy something.

This week, though, Lululemon (LULU) found itself dealing with a rare stumble. On Monday the company released a statement saying that a batch of its black "Luon" pants — stretchy bottoms made from a combination of nylon and Lycra spandex — that hit stores earlier this month have been pulled since Lululemon found out the fabric is too sheer. This affects about 17% of all its women's bottoms.

That style pant can cost $70 to $100. The company expects a shortage for the near future.

"This event is not the result of changing manufacturers or quality of ingredients," the company said in the release. "We are working closely with them to understand what happened during the period this fabric was made."

Company stock took a hit after the news, dropping more than 5% early Tuesday, but closing down 2.8%. The news comes ahead of Lululemon's fourth-quarter earnings out Thursday, but Christian Buss, an analyst who follows the company for Credit-Suisse, says the issue won't have a huge impact on near-term earnings power. .

"But longer term, we have to ask the question whether or not they're diluting their relationship with their core customers," he says. Buss notes this is the fourth product problem the company has had in the past year, during which it's also dealt with sheerness issues in bathing suits and some brightly colored products, as well as color-bleeding.

"They've taken on more risk (by placing larger inventory orders) and that's led to some quality-control issues," Buss says.

The flub is unusual for a company that has otherwise been on a successful climb. Lululemon's 211 stores — 178 of which are in the U.S. and Canada — are ranked third on research and consulting firm Retail Sails' list of most productive chain stores in 2012, behind just Apple and Tiffany. Its stores sell nearly $2,000 per square foot and do an average $5.5 million annually.

But for Lululemon, sales are just one piece of a brand that's just as much about selling a product as it is about selling a way of life.

"The No. 1 goal is really building healthy communities," says CEO Christine Day. The company — which started as a yoga outfitter for women — does that in a number of ways, from offering free yoga at stores, to helping brand ambassadors launch their careers in fitness, to sponsoring a half-marathon in its native Vancouver, B.C., for the second time this August.

"They're selling a brand identity," Buss says. "The model for retail used to be, come here and be cool if you buy our product. The model that Lululemon is trying to build is, you're pretty cool, we'll be your partner in being your best possible self. And that kind of turns retail on its head."

A COLORFUL OUTLOOK

Walking into a Lululemon store, customers are greeted by cheery employees, both in attitude and in outfit. They're often decked in head-to-toe Lululemon gear, like a pair of bright blue leggings paired with slippers or a soft yellow-striped tank top with pink sports bra straps showing through. Your eyes are drawn to pops of color, with almost every product available in a range of them — black usually, but also peach, turquoise, yellow, orange, mint green or any other color of the moment. (The brand rotates products and colors often, so nothing is around for long.)

Because of the brand's yoga roots, most of each store is dedicated to stretchy leggings and tops. An entire wall of the store holds shelves of leggings in various lengths, fabrics, colors and patterns. Lululemon calls them "wunder unders" and they're one of the brand's signature items and a best-seller. Any displays that take up floor space are on wheels, so they can be pushed aside when stores hold yoga classes on weekends. A community board gives customers information on local yoga studios and running clubs, and employees, who go through goal-setting workshops, post their aspirations on the store walls for anyone to read.

"It's really about being a fitness and conversation hub," Day says.

Before Lululemon opens a location, it sends employees to start recruiting ambassadors and developing ties to the community, cultivating the new relationships sometimes for years before launching a full-fledged store. During that time, it opens showrooms instead, which are only open a couple of days a week, offering yoga classes and limited product selection to introduce the brand concept.

Lululemon was essentially founded as half yoga studio, half apparel shop. Founder Chip Wilson opened the first showroom in Vancouver, B.C., in 1998, inviting the local yoga community to try out products he was developing by wearing them to free evening classes held in a studio above the storefront.

Wilson now serves as chairman of the board, and the company continues the model he started. Every year, employees at each store choose a group of five to eight community ambassadors to represent the brand and offer feedback on new products. Customers can do the same while they shop, with store employees — or "educators" as Lululemon calls them — writing down suggestions on a chalkboard posted near the fitting rooms.

Stores sell fun, colorful and, by all accounts, extremely comfortable workout gear. More than half of it is designed for yoga, and almost all of it made from a mixture of stretchy, sweat-wicking nylon and spandex.

The company creates almost every product out of two fabric blends: one they've coined "luon," a mix of 87% nylon and 13% Lycra spandex; the even stretchier "luxtreme" ups the Lycra spandex portion to 23%.

Sports bras could be anywhere from $40 up to almost $70, and hoodies and jackets are usually $100 or more. But that doesn't seem to deter Lulu-lovers.

Handali admits that the store is "pricey," but she keeps going back "because I know I'm going to get a quality product, and I know that that's the first thing I reach for when I want to put on a pair of leggings or a good sports bra."

And as Ferguson says, it helps that the clothes are simply cute. That's what got her exercising again. She first visited a store in 2011 with her younger sister, who convinced her to try on some clothes. She was so excited by what she bought that she was convinced to start running. Now she exercises five days a week and has lost 15 pounds.

"As shallow as it sounds, I had a cute outfit to wear," she says, "so I had to go exercise to wear my cute outfit."

TRANSFORMATION IS ENTICING

Offering a product that inspires a new lifestyle is a strategy that resonates with consumers, but it is usually easier for fitness brands like Nike, Under Armour, or Lululemon to pull off, says branding expert Eric Gustavsen.

Why? Because "they offer that promise of transformation," he says. And they make customers feel like they're a part of a group.

Since Lululemon entered the market, competitors have jumped on the opportunity to serve the niche consumer Lululemon singled out.

"Something as basic as an authentic yoga brand, I don't think anybody realized the power of that," Gustavsen says. "They've tapped into a lifestyle. Becoming connected with people and community is probably the most powerful thing you can do to build a brand."

Others are also trying to tap into the female-centric athletic apparel world, such as Lucy and Athleta. Athleta, which is owned by the Gap and opened its first stores in 2011 after operating as a catalog-only business for 12 years, even has its own version of ambassadors, called sponsored athletes, and sends customers out of the store with their purchases in reusable bags. Its stores offer weekly yoga classes and running clubs, and the brand sponsors a race series.

Lululemon is hard to replicate, though, Buss says, given the time and commitment the company invests in its communities and customers. Ambassadors and showrooms "help drive excitement and word-of-mouth buzz about this new concept that you can't get at the normal mall," he says. "It gives you insider status when you do buy the product."

And despite competitors, Lululemon has an edge by being first to market, Buss says. "This is a rising-tide situation because athletic apparel is one of the few growing categories in women's apparel," he says. "And that's a big advantage for Lululemon because they are the originator of that market."

In a highly competitive retail environment clamoring for customers' attention, Lululemon also relies entirely on word-of-mouth advertising. And the strategy goes a long way toward increasing sales.

The company has posted double-digit sales growth every quarter for the past two years. Though fourth-quarter 2012 results are out Thursday and are expected to be in the high single digits after a slower holiday season. For the third quarter, ended Dec. 6, 2012, the company had same-store sales growth of 18%.

Even more growth is expected for 2013. The company plans to look into launching in 15 new markets over the next two years, including more showrooms in London and a store in Hong Kong. Lululemon is also expanding its men's line, which currently makes up about 12% of stores, and a separate store concept for young girls called Ivivva. Ivivva launched last summer and now has five showrooms in New York, Boston, Chicago, Seattle and Los Angeles.

In January, Day was honored at the annual National Retail Federation convention in New York City as international retailer of the year, joining the ranks of big-name international retailers such as Burberry and Zara.

She was chosen because of Lululemon's company culture, says Mike Gatti, NRF's senior vice president for member relations.

"If I were to say Lululemon has a superpower, it's engagement," Day says. "We're not afraid to have a good time, to have a good laugh, stand for something, create a conversation. Our clothing is a medium for people to live a life they love."

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