Economies of scale provide a significant advantage in the retail industry. This is the reason why all retail companies try to become bigger. However, to the surprise of many American retail giant GAP Inc has decided to reduce its size. GAP is home to many famous brands like GAP, Banana Republic, Old Navy, Athleta, Intermix, and Hill City. As per the details released to the public, the Old Navy brand will be spun off into a separate company. A new name has not been decided for this company as of now. It will be called “Newco” till a new name is decided. On the other hand, all the other brands continue to remain with GAP. The size of both new companies will be more or less similar. This means that GAP has simply broken the company into two parts.

There are many analysts who believe that it may be a good idea to do so. However, there are many others who do not believe this is the case. In this article, we will have a closer look at the GAP- Old Navy breakup and try to figure out whether this break up makes any economic sense.

Why did GAP and Old Navy Break Up?

GAP has been struggling as a company. The results have been ordinary, and investors are starting to lose confidence. The Old Navy brand stands out as a clear performer in the GAP universe. This is because the market has moved towards low-cost discount retailers. As a result, brands like Old Navy are prospering. On the other hand, more expensive brands like the Banana Republic and GAP are seeing their sales decline.

Hence, GAP’s overall sales and profits are seeing a negative trend. On the other hand, Old Navy’s sales and profits have been seeing a positive trend. Up until now, Old Navy was just making up for all the losses that GAP is making. However, in the future, this is likely to change. Since Old Navy has now split up into a separate brand, all the excess cash flow and profits that it generates will be plowed back to fund its own growth.

It needs to be understood that Old Navy has been a remarkable growth story until now. The brand was initially created as a cheaper version of GAP during the 1990s. Ever since then, the brand has been growing each year aggressively. The brand now generates a massive $8 billion in sales worldwide! Investors are likely to queue up to invest their money in Old Navy since they believe that it is a winning business model.

How the Breakup will Help?

Firstly, the GAP- Old Navy breakup will help the company prioritize its resources. For instance, since Old Navy is a discount brand, it’s in store sales are greater than its online sales. This is the reason why Old Navy is the only brand within the GAP umbrella, which plans to increase its store base. GAP, Banana Republic and all the other brands actually plane to reduce their store base drastically. This is because the majority of their sales are taking place online.

The strategy needs of the Old Navy brand are very different from the rest of the company. This brand needs to follow the strategy of aggressive growth. In order to achieve this growth, it needs more capital. However, the cost of capital is very high, given that laggards like GAP are also part of the same brand portfolio. By spinning off Old Navy into a separate brand, GAP has made it possible for them to achieve more funding at a better cost.

On the other hand, the strategy of other brands like GAP and the Banana Republic is likely to be more defensive. They are more likely to cut down costs and eliminate overheads to deliver bottom-line growth to investors even if the top line doesn’t change much. Rationalizing costs is the need of the hour for all other brands in the GAP portfolio except Old Navy.

Issues with the GAP-Old Navy Breakup

The GAP-Old Navy breakup is likely to post many issues as well. Firstly, up until now, both these brands have been jointly rewarding loyalty. Now, since these brands will split up into different companies, it will be difficult to divide the loyalty points so that the consumers can redeem them.

Also, both the companies had significant economies of scale when it came to making purchases. It will be interesting to see whether the suppliers renegotiate their purchase agreements with the company. If they do not, maybe both these companies can stick together as sister concerns while making purchases. This is because all GAP brands are trying to reduce their costs. A cost overrun is one of the last things they need, given the fact that the very survival of the brand is in question.

The reality is that even though GAP is a legendary brand, it will still face several issues in the future. If the company is not able to get its act together and reinvent itself, it could be the beginning of the end for GAP Inc. It will be interesting to see how the future plays out for this company.