GRADUATE SCHOOL OF BUSINESS

STANFORD UNIVERSITY
CASE NUMBER: EC-9A
FEBRUARY 2000

GAP.COM

“This is about being clicks and mortar – letting customers

access the Gap brands, whether in the store or online” –
Ron Beegle, E-VP, Gap Inc.Direct

One of the first bricks and mortar retailers to venture online, Gap Inc., headquartered in
San Francisco, was widely considered an e-commerce pioneer in an industry renowned for its
resistance to change. Long before other apparel companies were even considering a foray into
cyberspace, Gap began developing its online strategy, re-examining its infrastructure, and
shoring up key areas that would be needed to support its e-venture. While Gap recognized the
opportunity the Web offered to leverage customers’ familiarity and loyalty to Gap brand, the
value of the brand was Gap's biggest concern as the online strategy was developed. Gap's first
web site was launched in December 1996. The site was informational, and did not offer
commerce opportunities. In November 1997, however, the online store was opened at
www.gap.com and in 1998, GapKids and babyGap went online, followed, in 1999 with
BananaRepublic.com and oldnavy.com.

Staying ahead of industry trends had long been a key to Gap’s success; the company had
reinvented itself several times, introducing new brands, innovating merchandising and becoming
synonymous with high-value, casual style. While the company had seen downturns, Gap had
largely escaped the typical vagaries and cycles of the fashion apparel industry, and had
consistently grown faster than the industry. In the first years of Gap’s on-line expansion,
analysts estimated that Gap outpaced nearly all other apparel retailers in online sales: the
company was believed to be the biggest generator of apparel sales on the Web. (Exhibits 1 and 2
provide overall Gap financials)

COMPANY BACKGROUND
In 1969, Don Fisher, a 41-year-old real estate developer, and his wife Doris opened the first Gap
store in San Francisco. The company took its name from the "generation gap" and targeted the

Research Associates Katherine McIntyre and Ezra Perlman prepared this case under the supervision of Professor
Garth Saloner and Professor A. Michael Spence as the basis for class discussion rather than to illustrate either
effective or ineffective handling of an administrative situation. The development of this case was managed by
Margot Sutherland, Executive Director, Center for Electronic Business and Commerce, Stanford Graduate School of
Business.
Copyright © 2000 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or
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Version: (D) 09/26/00
Gap.com EC-9A p. 2

late-teen customer. Fisher sought to build his brand around a single product – Levi's jeans –
which he offered in a broader array of styles and sizes than consumers could get elsewhere. The
Levi's strategy was an early hit, and the Fishers expanded their concept to new locations – by the
end of 1970, there were six locations. Six years later, with 204 units, the company went public.

In 1974, after the margins on Levi's began to erode due to an FTC regulation that allowed
retailers to discount Levi's products, Gap introduced several private-label lines. Gap decided that
the private-label strategy would pull the company out of price-based competition with larger
retailers. With the introduction of private-label clothing lines, Gap took over control of the entire
supply chain, owning or overseeing the product development from concept to customer, and was
able to hold pricing constant and base competition on product and brand image.

In 1983, Millard (Mickey) Drexler joined the company as president of Gap Stores, when there
were 566 Gap stores. Drexler came to Gap from Ann Taylor, an upscale women's mass retailer,
where he had built a reputation for establishing large consumer brands. Drexler undertook
improving the stores’ margins, driving growth, and re-defining Gap's image. Among Drexler’s
early initiatives was the decision to consolidate the multiple private label lines into a Gap brand.
He was also lauded for his innovative merchandising strategies. Gap, Inc. began to extend its
reach beyond the flagship Gap brand, beginning with its 1983 acquisition of Banana Republic.
This initiative was quickly followed by the first GapKids store, opened in 1986. In 1987 Gap
began its international expansion plans and opened its first London location. In 1989, GapKids
launched the BabyGap line of infant and toddler clothing, In 1991, Drexler decided that Gap
stores would no longer sell Levi’s (Levi’s represented less than 2% of sales at the time) and
moved Gap to private-label-only products. Under Drexler's leadership, Gap launched innovative
advertising initiatives, including the well-known and creative campaign ‘Who Wore Khakis.’ In
1994, the Old Navy brand was introduced. Drexler later worked to reposition Gap as a
ubiquitous, global brand, rather than simply a retail chain.1

With its multiple brands, Gap pursued a market segmentation strategy; each brand represented a
unique image, and catered to a distinct demographic. The middle market was targeted with
casual, basic styles. Although Gap’s sweet spot was the college-age customer (more female than
male), teens and 25 to 35 year-olds were also targeted as customers. Banana Republic focused on
an older and more affluent consumer, and offered more stylized products. Old Navy targeted
families, and focused on the bargain-minded consumer, offering fashionable, value-oriented
clothing at lower price points.

In April 2000, there were 3145 stores across all Gap Inc. divisions and Gap Inc. accounted for
approximately 5% of all apparel dollars spent in the U.S.2 (Exhibit 3) Although same-store sales
growth slowed at Gap flagship stores in 1999, as a result, some analysts believed, of Old Navy's
success, most analysts were confident that Gap’s aggressive plans for new stores, the successful
Old Navy format, and Drexler’s consistent ability to reinvent Gap, would continue the
company’s historical success. Thirty years after entering the retailing industry, Gap had an
established, prominent position in the specialized retail apparel industry, and consistently
achieved among the highest margins in the industry.

1
Nina Munk, “Gap Gets It”, Fortune, August 3, 1998.
2
Tradeline, June 25, 1999.
Gap.com EC-9A p. 3

COMPANY STRUCTURE
Gap’s internal structure was organized to support the company's goal of specific identities for
each of the clothing-brand lines (Gap, Banana Republic and Old Navy). Each brand was
established as a subsidiary/division of Gap Inc., and was charged with maintaining complete
control of its product through a highly vertically-integrated corporate structure. In 1991, Gap
established an International unit. While the division was treated as a profit center, it was a
channel-based division, rather than a brand division.

ONLINE APPAREL SALES IN 1999

Although, by the end of 1999, online apparel sales had not grown as quickly as books or CDs,
they were rising steadily. As in other consumer markets, traditional retailers were looking for
ways to tap into this burgeoning market and protect their existing customer bases from online-
only retailers. Sales estimates for 1998 online apparel sales ranged from $330 million3 to $460
million,4 and expectations for 1999 sales ranged from $642 million5 to $1.4 billion.6 Longer-term
projections were similarly varied. Forrester predicted that online sales would be $20 billion by
20037 (7% of total apparel sales) and Jupiter expected 6% penetration by 2006. While analysts'
forecasts varied widely, the importance of the Web for apparel retailers was clear. Adding to
traditional retailers’ desire to develop a Web strategy were analyst predictions that most Web
sales would not be incremental gains, but rather simply channel shift as consumers moved their
existing purchases to the Web. Jupiter Communications estimated that only 6.5% of online
commerce sales in 2002 would represent incremental sales.8 While overall industry sales were
expected to shift rather than expand due to e-commerce, individual companies saw opportunities
for effective web initiatives to attract new customers and steal market share from competitors.

In addition to using the Internet as a vehicle for gaining market share, retailers believed the
Internet created an opportunity for them to solidify their brands, build closer customer
relationships, serve markets that were too small to profitably support a store, and improve profits
through cost savings. Opportunities for bricks and mortar companies to realize cost savings as
they moved operations to the Web existed in a number of areas. An assessment of the typical
expenses of a brick-and-mortar department store revealed that the use of the Internet as a
distribution channel could reduce costs in selling and support services, service and operations,
and property and equipment. (Table 1.0)

Although the Internet might provide pure play retailers with a lower cost structure, bricks and
mortar retailers with online stores appeared to have several advantages over pure-plays. Sales
potential for retailers trying to reach consumers through multiple channels were compelling —
50% of consumers who bought from the same company online and in stores spent more than
when they shopped only at stores.9 In Web-wide surveys, security was cited as a principle reason

3
Valerie Seckler, “A Warning to Stores: Get Online or Risk loss of share to net,” Women’s Wear Daily, August 4,
1999, p. 1.
4
Louise Lee, “ ‘Clicks and Mortar’ at Gap.com,” BusinessWeek, October 18, 1999.
5
Mercedes Cardona, “Apparel Makers Add E-Commerce,” Advertising Age, March 29, 1999, p. 38.
6
Louise Lee, “ ‘Clicks and Mortar’ at Gap.com,” BusinessWeek, October 18, 1999.
7
John Sterlicchi, “The Gap Promotes Web Commerce with Fashion News, Reminders, Discounts,” Knight Ridder
Tribune Business News, July 14, 1999.
8
Jupiter Communications, Channel Shift Study, June 1999.
9
Louise Lee, “ ‘Clicks and Mortar’ at Gap.com,” BusinessWeek, October 18, 1999.
Gap.com EC-9A p. 4

that online users had not made a purchase on the Web. Off-line brands had an advantage as they
went online, due to the established trust relationships they had with consumers.10 In addition, in
an industry where online sales were expected to be limited based on customers’ need to touch
and try on the product, offline retailers could satisfy this need, whereas Internet-only competitors
could not.

Table 1.0 Assessment of Typical Expenses of a Brick-and-Mortar Department Store

Source: NATIONAL RETAIL FEDERATION, 1997 © 1999 JUPITER COMMUNICATIONS AS OF 6/9911

FOR EVERY GENERATION, THERE’S A GAP

Given the compelling opportunities provided by online apparel sales, the Internet was a natural
extension of Gap’s efforts to control an increasing share of the consumer’s apparel dollars. The
company’s e-commerce efforts mirrored the strategy the company used to succeed in the offline
channel – establishing new markets, focusing on stylish value-driven product offerings, and
keeping value-drivers tightly controlled in house.

Gap began to consider the appropriate e-commerce initiative in 1996. Introduction of the
individual brands' web sites was staged over time: gap.com was introduced with e-commerce
capabilities in 1997, followed by the other brands over the course of the next two years. In 1999,
all of the sites were launched with e-commerce functionality, with the exception of the
oldnavy.com site where e-commerce functionality was not expected to be in operation until later
the following year.

Gap only launched a web property when all of the key business drivers were brought in-house.
The launch of the Old Navy web site exemplified Gap’s primary concern of protecting the core
brand. Gap chose to hold off on launching a commerce-enabled site until after what many

10
Valerie Seckler, “Buying in Cyberspace: Price may no longer be enough of a spur,” Women’s Wear Daily, April
14, 1999.
11
Jupiter Communications, Channel Shift Study, June 1999.
Gap.com EC-9A p. 5

analysts considered a critical time of the year, the 1999 holiday season. The company wanted to
ensure that the web site met Gap’s high standards. Analysts believed this was an example of
how web initiatives took a back seat within traditional companies when the expected return on
investment in bricks and mortar was higher.12 International was another case in point: a
worldwide roll-out of Gap Online was not expected until the end of 2000, after distribution
facilities to support the online initiative were in place.13

Each brand’s web site was designed to have the look and feel of the brand’s retail locations. The
online stores offered customers a broader range of sizes and a larger selection of products than
were available in most retail locations. Some products that were available only in select retail
locations (e.g., GapBody) were previewed on the web site. Product prices were comparable to
bricks and mortar stores (though without sales tax) and customers were allowed to return
products to bricks and mortar retail locations.

Gap web sites integrated technology to enhance the customer experience - including allowing
users to easily compare sizing on different cuts and styles, multiple navigation schemes, and the
retention of customer preferences through wish lists and other tools. The company benefited
from the deployed technology through extensive customer data collection. The web sites offered
Gap the opportunity to collect data on where customers lived, when they accessed the site, the
length of their visit, frequency of purchases, products selected and dollars spent – data the
company had never effectively collected or stored through its bricks and mortar locations.

PROMOTING GAP.COM
Promotions for Gap web sites, both online and off, were geared to drive customer registrations
and to collect e-mail addresses and often offered discounts and contests as incentives. Cash
registers at Gap and Banana Republic promoted the online store, and periodically ran promotions
that allowed customers the opportunity to register by filling out a form at the store or through
Web kiosks, where available. Gap used this contact information to send customized emails to
registered users promoting new arrivals, specials, and other promotional events, as well as
offering a birthday and gift reminder service. The email promotions proved successful, and
drove a significant percentage of online sales.

Out of the company's 1998 advertising budget of $400M14 (4.4% of total sales), Gap spent
approximately $3M on gap.com15 ads on the Web, and many offline Gap promotions included
the gap.com URL to drive further awareness. In addition to leveraging the formidable offline
Gap marketing power, the company began pursuing distribution partnerships with major web
brands. In 1999, Gap aggressively stepped up Web partnership efforts: in August, a three-year
anchor placement deal was signed with AOL to promote the Gap brands; in November a joint
marketing promotion was initiated between gap.com and etoys, as well as a partnership with CD
Now.

12
Advertising Age, September 6, 1999, p. 26. While Gap representatives denied the rumors, there had been talk on
Wall Street that Gap could spin off its Direct, Old Navy or Banana Republic units.
13
John Sterlicchi, “The Gap Promotes Web Commerce with Fashion News, Reminders, Discounts,” July 14, 1999
Knight Ridder Tribune Business News.
14
Women’s Wear Daily, February 26, 1999.
15
Women’s Wear Daily, October 29, 1998.
Gap.com EC-9A p. 6

CLICKS AND MORTAR

Gap executives echoed analyst expectations that apparel was a product uniquely positioned to
benefit from a multi-channel strategy. Gap saw their bricks and mortar stores not as an
impediment, as many Internet pure-plays liked to assert, but rather as a key asset that they
planned to increasingly leverage to provide the consumer with the most complete shopping
experience. Observers pointed to several examples of how the consumer benefited from an
established bricks and mortar retailer pursuing a multi-channel strategy:

• Return Policy: Whereas Internet pure-plays required the customer to deal with
the hassle of mailing back products that didn’t fit, consumers who bought
through Gap’s online stores could return products to any store location.

• Alterations: Purchases made at the Banana Republic web site or catalog could
be brought to any store location for free alterations (just as if it had been
purchased at a store).

• Trusted Brand: Gap’s well-established brand and reputation made customers

feel more comfortable making online purchases. Additionally, customer
retention rates for traditional merchants were 10 to 20 percentage points
higher than online-only competitors.16

• Pre-Shopping: Many customers valued the opportunity to do product research

on the Web, and then purchased at a bricks and mortar store.

• In-store promotions: Gap leveraged the stores to drive website traffic with a
variety of strategies, including Gap’s ‘surf.shop.click’ posters, and the recent
introduction of Web lounges in New York, Chicago, San Francisco, Los
Angeles and Aspen.

SUPPORTING THE NEW CHANNEL

Initially, the Online unit was set up as a sub-unit of the Gap division, but in third quarter 1998,
the company made the decision to break out a new division, Gap Inc. Direct. Gap Inc. Direct
division's responsibilities included the online properties for Gap, Banana Republic and Old Navy
and the new catalog business that began with the return of the Banana Republic catalog in Fall
’99 and was to be followed with catalogs for Old Navy and Gap. Ron Beegle, E-VP Gap Inc.
Direct, took on the responsibility of heading up the Direct unit in the spring of 2000. Analysts
estimated that the costs for the first 24 months of a traditional bricks and mortar retailer’s Web
initiative could easily exceed $30 million.17

Since Gap’s existing distribution system was optimized to ship large quantities of merchandise to
retail locations, supporting direct-to-customer shipments required the development of a pick,
pack and ship operation of individual items. Gap initially set up the online distribution
operations within existing distribution centers, but, shortly after the launch of the Gap web site,
the company established distinct warehouses for the online unit.
16
“A Man of Words Remains Partial to One: Loyalty”, New York Times, December 29, 1999, p C6.
17
BCG, ‘Winning on the Net: Can Bricks-and-Mortar Retailers Succeed on the Internet’, August 1999.
Gap.com EC-9A p. 7

Customer support was another area that needed to be built out. Prior to the Internet, Gap had
dealt with customers exclusively in the retail channel, and customer problems were addressed
within the store context. The development of the online unit saw the accompanying launch of
the company’s first 800-number, and the build out of a full-scale call center manned by Gap, Inc.
personnel.

HUMAN RESOURCES
Throughout the Internet industry, attracting the best IT workers was difficult at all organizational
levels. The fierce competition for top IT workers was in evidence when Gap hired new CIO,
Ken Harris. In mid-’99, Harris resigned as CIO at Nike and joined Gap. The new appointment
prompted a non-compete lawsuit from Nike.18

As the corporate unit drove promotions into the bricks and mortar channels, store personnel were
asked to promote the web site to their customers. For most of these workers, who constituted the
vast majority of the Gap's 190,000 employees, compensation was not tied to store sales; instead,
store management often created incentives through in-store employee contests. For store
managers, bonuses were tied to sales objectives that were established by district and regional
managers. Online sales had not yet been significant enough to cause concern from store
managers about the online channel as a competitor — a competitor they were asked to promote
daily in their store location.

RESULTS
While Gap did not break out online sales separately from overall brand sales, analysts estimated
gap.com sales for the year ending September 1, 1999 fell between $80 and $100 million.19 The
1999 sales figures represented a significant jump from analyst estimates of $20 million for Gap's
1998 sales.20 Based on overall industry sales estimates targeting online apparel sales for 1999 to
be between $640 million and $1.4 billion, Gap.com captured between 7 and 15 percent of online
apparel expenditures for 1999, a favorable comparison with the already formidable 5 percent that
Gap controlled for offline apparel sales.

Industry observers wondered whether Gap’s online strategy would be a source of sustainable
competitive advantage. In some ways, Gap seemed particularly well-positioned to pursue a
“clicks and mortar” strategy. For example, while high product returns were a big concern for
many apparel retailers as they considered their online strategies, Gap claimed that returns on the
company’s online sales were approximately the same as for store purchases.21 This low return
rate was attributed to the fact that most people knew their size for Gap clothes, as well as the fact
that casual clothes such as Gap’s were typically more forgiving in size than higher-end brands.
Even more importantly, perhaps, Gap owned its retail outlets and believed that the company was
in a better position to manage conflict between the online and offline channels. Would this give
Gap an advantage over manufacturers who did not have captive downstream channels?
18
Jennifer Mateyaschuk, “The New CIOs,” Information Week, August 16, 1999, p. 18.
19
Louise Lee, “ ‘Clicks and Mortar’ at Gap.com,” Business Week, October 18, 1999. Estimated online sales for
JCPenney.com over the same period were $60-80m, $55-75m for Eddiebauer.com, $40-60m for JCrew.com, and
$25-40m for Victoriasecret.com.
20
Ibid
21
Ibid
Gap.com EC-9A p. 8

Exhibit 1
Gap Inc. 1999 Quarterly and Annual Financial Statements
Source: 1998-99 Gap Annual Report

Quarterly Figures: (GPS)

Oct 1999 Jul 1999 May 1999 Jan 1999

Income Statement US$ (000) US$ US$ US$
Summary (9-MOS) (6-MOS) (3-MOS) (YEAR)

Total Revenues 7,776,459 4,731,073,000 2,277,734,000 9,054,462,000

Cost of Sales 4,518,798 2,777,700,000 1,334,155,000 2,403,365,000
Other Expenses 2,106,088 1,308,446,000 615,149,000 0
Loss Provision 0 0 0 0
Interest Expense 18,366 7,809,000 4,638,000 13,617,000
Income Pre Tax 1,133,207 637,118,000 323,792,000 1,319,262,000
Income Tax 419,991 238,919,000 121,422,000 494,723,000
Income Continuing 713,216 398,199,000 202,370,000 824,539,000
Discontinued 0 0 0 0
Extraordinary 0 0 0 0
Changes 0 0 0 0
Net Income 713,216 398,199,000 202,370,000 824,539,000
EPS Primary $d; $d; $d; $1.43
EPS Diluted $0.79 $0.44 $0.22 $1.37

Annual Figures: (GPS)

Jan 1999 Jan 1998 Feb 1997 Feb 1996

Income Statement US$ US$ US$ US$
Summary (YEAR (YEAR) (YEAR) (YEAR)

Total Revenues 9,054,462,000 6,507,825 5,284,381 4,395,253

Cost of Sales 2,403,365,000 1,635,017 1,270,138 1,004,396
Other Expenses 0 -2,975 -19,450 -15,797
Loss Provision 0 0 0 0
Interest Expense 13,617,000 0 0 0
Income Pre Tax 1,319,262,000 854,242 748,527 585,199
Income Tax 494,723,000 320,341 295,668 231,160
Income Continuing 824,539,000 533,901 452,859 354,039
Discontinued 0 0 0 0
Extraordinary 0 0 0 0
Changes 0 0 0 0
Net Income 824,539,000 533,901 452,859 354,039
EPS Primary $1.43 $1.35 $1.58 $2.46
EPS Diluted $1.37 $1.30 $1.58 $2.46
Gap.com EC-9A p. 9

Exhibit 2
The Gap, Inc. Ratio Comparisons*
Source: Market Guide, Inc. Published by OneSource Information Services, Inc., December, 1999.

Growth Rates(%) Company Industry Sector S&P 500

Sales (MRQ) vs Qtr. 1 Yr. Ago 26.89 19.58 31.90 19.79

Sales (TTM) vs TTM 1 Yr. Ago 31.94 21.57 28.43 16.59

Sales - 5 Yr. Growth Rate 22.40 19.13 25.85 19.82

EPS (MRQ) vs Qtr. 1 Yr. Ago 33.21 24.80 10.13 20.95

EPS (TTM) vs TTM 1 Yr. Ago 43.38 29.93 22.67 27.16

EPS - 5 Yr. Growth Rate 27.75 30.00 24.93 23.00

Profitability Ratios (%) Company Industry Sector S&P 500

Gross Margin (TTM) 41.75 38.69 42.96 50.16

Gross Margin - 5 Yr. Avg. 37.99 35.02 40.50 48.60

EBITD Margin (TTM) 19.00 16.18 16.64 23.23

EBITD - 5 Yr. Avg. 18.04 14.92 17.26 21.95

Operating Margin (TTM) 15.37 13.16 10.13 18.54

Operating Margin - 5 Yr. Avg. 13.88 11.52 7.50 17.04

Pre-Tax Margin (TTM) 15.13 12.89 12.22 16.25

Pre-Tax Margin - 5 Yr. Avg. 13.88 11.47 7.39 16.02

Net Profit Margin (TTM) 9.50 7.93 2.24 11.87

Net Profit Margin - 5 Yr. Avg. 8.51 7.19 3.96 10.52

*Information was current as of 12/23/1999

Gap.com EC-9A p. 10

Exhibit 3
Gap Inc. Store Growth
Source: Gap Inc. 1998 Annual Report and Q1 2000 Report

Net New Stores

Year Ending Total Stores
April 29, 2000(a) April 29, 2000

GAP
Gap Domestic 279 1812
Gap International 107 433
BANANA REPUBLIC 59 354
OLD NAVY 126 546
TOTAL 571 3145

1998 1997 1996 1995 1994 1993 1992 1991 1990

Number of Stores Opened 318 298 203 225 172 108 117 139 152
Number of Stores Expanded 135 98 42 55 82 130 94 79 56
Number of Stores Open at Year- End 2428 2130 1854 1680 1508 1370 1307 1216 1092
Net increase in number of stores 14% 15% 10% 11% 10% 5% 7% 11% 14%
Comparable store sales growth 17% 16% 5% 0% 1% 1% 5% 13% 14%