This article is from the Globe and Mail Lululemon Stretches to Balance Expansion Against Profit  by Marina Strauss

Lululemon’s chief executive officer is betting that pumping up the company’s investments in testing new product lines such as swimwear while building up inventories of its core yoga products will pay off in the long run.But the cost of ramping up her strategy is dampening the company’s 2012 outlook, which on Thursday fell short of analysts’ targets and prompted the stock to tumble nearly 9 per cent. Investors were unnerved by the company’s fast-rising stockpiles of clothing.

In its bid to ensure that shelves aren’t empty when shoppers are looking for items, the company boosted inventory levels 67 per cent in the first quarter. And Lululemon’s product pilots are expected to help push its gross profit margin below 55 per cent in the coming months, according to the company’s forecast, compared to about 57 per cent last year.

Ms. Day is convinced she’s on the right path. “I really don’t feel the need to apologize for that level of performance and growth track record that we have,” she told analysts on a conference call. “Balancing short- and long-term [objectives] and the impact it has on an organization that is still growing infrastructure – that is our job and we think we do it pretty well.”

She is engaged in a delicate balancing act as she strives to build the athletic-wear retailer even as inevitable imperfections start to surface.

Lululemon has counted on its core yoga line to serve up healthy returns, but the company today feels the urgency to move into new areas because the shelf life of yoga wear as a phenomenal growth story may be limited.

And after struggling with a shortage of products last year, which held back sales growth, Lululemon has built up inventory levels dramatically, putting pressure on the company to match supply to demand and still ensure its premium products can command a top price to deliver high margins.

“You don’t want a small company [like Lululemon] to be stretched too thin,” said Jaime Katz, retail analyst at Morningstar Inc. in Chicago. “It’s a double-edged sword: You get penalized for straying from the core product. But you can’t grow yoga forever.”

Lululemon investors have long watched nervously for any sign that its growth might falter. The company beat its own and analysts’ forecasts in the first quarter, with same-store sales at outlets open a year or more – a key retail measure – climbing 25 per cent. However, investors were rattled by the company’s outlook that those sales will only pick up in the “low double digits” in the current quarter.

For the full year, the retailer projected revenue of up to $1.34-billion and profit per share of as much as $1.60, at least three cents below analysts’ expectations.

“These are things that will compress our margins in the short term, but we also can translate some of those [lessons] to other product lines,” she said. “It’s the right thing as a market leader to continue to innovate.”

Still, Ms. Day said the company’s investment in testing small batches, or “capsules,” of products in new categories will pay off in new lessons it can apply to other merchandise. In a bigger gamble, Lululemon will launch eight capsules this year, compared with two or three in the past year.

But in the rush to develop new lines and products, the retailer isn’t compromising on the quality of its products, she said. And it has factored product-development mistakes into its forecasts, she said.

For instance, the chain wrestled with some dyes that didn’t work, and was forced to pull some merchandise to ensure it didn’t put “bad product” on the floor.

“They weren’t big mistakes,” Ms. Day said. “But we don’t want to make those kind of mistakes and put that out in our [customer’s] hands … That is the business we are in, not quick turn, high-volume T-shirts.”

She’s racing to find the right balance between her model of scarcity – not stocking too much of an item, so that customers are forced to return for more – and not over-ordering an item.

“If we chased an extra amount of pink when yellow is what is needed, we really just create, in our opinion, future markdowns and destroy the brand.”

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