How to Set High Prices by Focusing on Niche for Better Life

Businesses that focus on a niche can set higher prices and achieve better profit margins. Today, we’ll examine a perfect example of this strategy and learn how it’s done.

Lululemon’s business is very successful. You can see this very well when you compare its financial statements to rival Under Armour’s. Apparently, Lululemon makes way more cash from high profit margins, and its market value is more than 10 times higher than Under Armour’s. This is mainly because Lululemon has narrowed its target market and solved a particular problem for that target.

Under Armour’s target: mainly men but also women who do sports, so they are selling to everybody. The target’s problem: they want sportswear… right? And they don’t have any. Their solution: provide that sportswear!

Lululemon’s target: Adult working women who love yoga and attend yoga classes. (See? A very narrow target.) The problem: In the past, there was no sportswear for women, so they had to wear small-sized men’s sportswear. Lululemon’s solution: very fashionable yet comfortable yoga wear for women.

See? By solving this niche-specific problem, Lululemon is, of course, charging much higher prices. That contributes to their high profits and plenty of cash flow. But normally, selling at a premium price makes the selling speed slower. Which one do you buy more often, eggs or a necklace from Tiffany’s? Cheap things sell faster. But selling expensive things without cutting prices is very hard. Lululemon, however, is selling at premium prices fast, even the fastest among premium-priced brands.

To see how fast it is selling, we can use the Days Inventory Outstanding (DIO). It shows how long it takes to sell all the inventory you have. It is calculated as inventory/cost of sales × 12 months.

For example, in 2023, Lululemon’s inventory was $1.3B, and its cost of sales was $4B, so its DIO was 1.3/4 × 12 = 3.96 months. This is the shortest among rivals selling at premium prices, like Levi Strauss (5.8), Ralph Lauren (5.6), and VF Corporation (which owns The North Face, Timberland, and Vans) at 5.0. By selling things faster, you can free up your cash. Even a 1 to 2 month difference is huge. When the yearly cost of sales is $4B, a 1-month inventory increase means you have to put an additional $4B/12 = $334M into operations.

Normally, when sales increase, you have to put more cash into operations, so the cash amount decreases. But by having fewer assets, you can make your company cash-generating more easily. So how does Lululemon avoid having unnecessary inventory? I think it comes from its ambassador system.

Lululemon has ambassadors in its stores, and they are usually Yoga instructors, giving free yoga lessons to Lululemon customers. But Lululemon doesn’t pay anything to those ambassadors. The ambassadors get an important reward instead: by becoming an ambassador, they can get exposure on Lululemon’s platform and use Lululemon’s reputation to attract people to their free lessons and later make them their own clients. The ambassadors giving free lessons makes Lululemon’s clients develop a cult-like following.

The ambassadors, who are actual users and targets of the product, have to provide feedback to help Lululemon develop products. Lululemon can get honest opinions to ensure the products resonate well with customers.

This is very important. Lululemon avoids making unnecessary products that stay long on the shelf by making them with their actual target market in mind.

The cult followers buy products immediately after they are released, allowing Lululemon to sell fast.

Also, the products’ fabric is very similar, using nylon and polyester. That reduces dead-stock materials.

Finally, they narrowed down their products, so they have fewer items compared to rivals. Having fewer products and focusing on products that sell fast, of course, reduces the inventory amount and cycle period.

To see this, I searched for the number of women’s leggings each online shop has in June 2024:

Athleta: 228 items

Alo: 158 items

Nike: 140 items

Lululemon: 112 items

Lululemon sells way more yoga items than its rivals but still has fewer items than even Nike, whose focus is mainly on shoes. Apparently, it is narrowing its product portfolio down – a good move.

Having physical stores is very important to Lululemon. They can control the customer experience when they buy. Also, the ambassadors giving lessons in-store is a very important factor in selling at high prices by enhancing customer satisfaction.

The high profitability and economies of scale seem to be a trade-off situation here. They have to manage their own retail stores by hiring talented managers, sales reps, etc. Each time they increase sales by increasing stores, the costs move at the same time. The cost rate never changes. The net profit rate (net profit/sales) around 2010 was an average of 16% and in 2023 it is still 16%, even though sales have increased more than 10 times.

The cost structure is similar to Starbucks or WeWork. It’s difficult to achieve economies of scale.

By the way, the majority of their retail shops are leased, so they don’t have to build each time they increase sales. The cash outflow of building a new shop is huge, which becomes a limitation on sales expansion. Using leases is a good solution for that.