July 6, 2014

LULULEMON ATHLETICA: EARLY DAYS, PURSUING GROWTH

On Christine Days first Sunday as CEO of lululemon athletica, a $350 million publically traded
athletic apparel company, she was working the cash register at one of the Vancouver-based
companys stores. As per lululemon tradition, every employeefrom accountants to the executive
teamhad to spend at least eight hours each month working in stores, so as to remain connected with
the companys clientele. When Day stepped into her new role, in June of 2008, lululemon had close
to 100 stores and 3,000 employees. Day had never before been a CEO, but had spent nearly two
decades at Starbucks. Most recently she had headed Starbucks Asia-Pacific operations, where she
had learned important lessons about carefully managing rapid growth.

This experience was crucial, because lululemon was growing at breakneck pace. In 2007, sales had
risen 85% to $275 million; profits had risen 300% to $31 million. Plus, the company had raised $344
million in its 2007 IPO. 1 Days directive from the board was to continue the growth and help make
lululemon a billion-dollar company. On the surface, lululemon looked great. As one Credit Suisse
analyst said, Its the best growth story in retail today, citing lululemons sales per square foot,
which were triple the rate of red-hot retailers like J. Crew and Abercrombie & Fitch. 2

All involved knew, however, that Days task would be a tremendously challenging: dangers were
lurking behind the numbers. Days predecessor, Bob Meers, the former CEO of Reebok and the first
to lead the company after founder Chip Wilson stepped down, had fulfilled his mandate to grow
lululemon quickly. But doing so was not without costs. Since its 1998 founding, lululemon had been
run by a tight-knit group of passionate employees who had built the business by trying to be anything
but business as usual. Meers had brought in a seasoned management team, and an us versus them
mentality had developed between some company veterans and newcomers. Morale was not the only
problem. In addition, lululemons aggressive growth strategy in the US had led to poor store
locations, and inventory management issues, including rising inventory costs. Sales per square foot
had dropped from $1,710 to $1,451 and same store sales had dropped from 24% to 3%.

Day knew she had to restore the companys health while pursuing high growth, but coming from a
values-based company like Starbucks, she knew she had to do it in a way that was consistent with
lululemons culture. It was a daunting task, but Day was energized to be working for a company
whose products she loved, and whose philosophy spoke to her personally.

History

Lululemon was founded in 1998 by Dennis Chip Wilson. Wilson was a Canadian entrepreneur
who in 1979 founded Westbeach Snowboard Ltd., which sold surf, skate and snowboard apparel.

1
McConnon, A., lululemons next workout: Can Christine Day broaden the yoga lothiers appeal? BusinessWeek, May 29, 2008.
2
McConnon, A., lululemons next workout: Can Christine Day broaden the yoga lothiers appeal? BusinessWeek, May 29, 2008.
In the mid-1990s, the company reached $15 million in sales and had operations in the US, Canada,
Austria and Japan. In 1997, Wilson sold Westbeach and settled with his family in Kitsilano, a trendy
suburb in Vancouver, British Columbia. The towns temperate weather, coupled with expansive
beaches, parks, and a relaxed West Coast vibe, made it an ideal place for Wilson to reflect on his next
venture. He began attending yoga classesthe first commercial ones available in Vancouverand he
found them exhilarating. The post-yoga feeling reminded Wilson of how he felt after a good day of
snowboarding or surfing, and it seemed obvious to him that yoga was poised to take off in the years
ahead. Moreover, Wilson saw an opportunity in yoga apparel. At the time, most all yoga garments
were made of cottona fabric that got too sweaty to be comfortable during long, intensive sessions.
Given that Wilsons passion was in technical athletic fabrics, he decided to create a company that
would make . . . the best, high-quality clothing for yoga. 3

With this, Wilson founded lululemon, in 1998. To do so, he had to remortgage his house, which left
him with just $300,000 to work with. But from the start, Wilson had focus: he wanted to make
feminine, high quality, high tech athletic clothing that enhanced the body and was targeted to
professional women. 4 He had a vision too: To elevate the world from mediocrity to greatness.

But heading toward greatness meant starting small. Strapped for cash, Wilson opened a design studio
that doubled as a yoga studio at night to help pay the rent. It was deliberately located in Kitsilano,
since this suburbs fashion-conscious residents set trends for the rest of Canada. As customers made
purchases, Wilson solicited their feedback. Lululemon manufactured clothing in small batches to
allow for constant iteration, and often there were dozens of changes before a product was ready for
market. The company also developed close relationships with yoga instructors, who were asked to
wear lululemon products and provide insights on their experience.

Strategy

From early on, lululemon competed on quality not price. To differentiate the products, Wilson
developed proprietary fabrics such as Silverescent, Vitasea and Luon. Silverescent, with its
incorporated silver particles, had antibacterial properties. Vitasea was a fabric that was developed
from a seaweed compound. According to lululemon, it released amino acids, minerals and vitamins
directly into the skin. Luon was a fabric that wicked away moisture, was flexible and was designed to
reduce irritation. 5 Wilson was able to develop these differentiators by relying upon contacts he had
fostered in his previous venture. His belief was that if lululemon focused on making the highest
quality garments possible, then its products would be difficult for competitors to copy, and that
customers would be willing to pay a premium.

Lululemon exclusively manufactured and sold its garments. All clothing was stitched together using a
process called flat steaming, which improved the feel of the garments. Clothing was also pre-shrunk
and lululemon offered customers free alterations, as well as regular and tall sizes. Garments such as
pants were priced at $80-$90 each (other brand name companies charged half this price for their
products). Gross margins were over 50%. Quickly, the top-selling item became the lululemon pant,
made from Lycra, a form-fitting material.

3
Chip Wilson, National Post Business Magazine. December 2004.
4
Paul Luke, Fashion Guru Saw it Coming as a Kid, The Province (Vancouver), August 26, 2001, p. A43.
5
lululemon athletica Inc., Form S-1ASecutiries Registration Statement, July 9, 2007, p. 88.

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Lululemons approach to reaching its core customers was to not actively pursue themat least at
first. In its store openings, the company targeted different customer segments over time. The first
store in a new location was designed to catch the attention of women who lululemon called influencer
types: 32-year old, single, affluent and athletic women. This group did not represent the core
lululemon buyer, who was older and aspired to look younger. But, the young, athletic singles were
urban residents and set trends for the core customer group. Sometimes, lululemon first opened
showrooms which opened for sales during limited hours, creating pent-up demand. The company also
invested energy in generating excitement about the brand amongst yoga instructors, athletes and other
community influencers. Once traction was gained in key neighborhoods, full-scale stores were built
out. These stores offered yoga classes and community events in addition to retail sales. Next, a second
round of stores was established, once again in urban locations, but this time with a mix of both
influencers and core buyer types. Finally, stores were then established in the suburbs, where core
buyers concentrated.

Culture

A distinctive lululemon culture had emerged from Wilsons years of working with a close group of
employees, and everyone inside the company believed that the culture was crucial to the companys
success. Lululemon had a manifestoone created when Wilson and his father collected a set of
inspirational sayings such as, Breathe deeply and appreciate the moment. Living in the moment
could be the meaning of life and Sweat once a day and Life is full of setbacks. Success is how
you handle the setbacks. These phrases became words to live by for employees. They were shared
with customers tooafter making a purchase, customers received printed copies on the special
shopping bags printed for the store. Many noted that the manifesto really impacted their lives.

Lululemon carefully tended its culture, and the manifesto proved a useful mechanism for attracting
and screening potential employees. Lululemon had found that if the manifesto spoke to a potential
new employee, the employee was more likely to be a good cultural fit. During training seminars,
employees were encouraged to set goals for themselves and to try to live their dreams in all aspects of
their livespersonal and professional. Employees were asked to draft one, five and ten-year goals;
this information was then posted on the walls in stores and at headquarters. Even board members
performed this exercise. Similarly, lululemon employees were expected to bring their whole selves to
work. As an employee said, I've never before worked for a company that cares so much about my
lifeThey genuinely want you to be proactive in your own life. 6

Employees were required, as part of the job hiring process, to actively live and breathe the lululemon
culture and lifestyle. This meant, in part, leading an active lifestyleas Wilson had found, the daily
rush of exercise he always made sure to receive helped him, he believed, to make better decisions.
When employees reached one year of service, lululemon sponsored them to attend Landmark Forum
workshops, a series of seminars designed to help individuals free themselves from barriers of the past,
and to learn to live in the present and design an inspiring future. All employees enjoyed benefits like
free yoga classes, and hourly wages that were 30% higher than standard minimum wage paid for most
retail positions.

Lululemon had also evolved a set of core valuesquality, product, integrity, balance,
entrepreneurship, greatness, funwhich helped to unify the employee base. During job training,

6
Bogomlony, L., Toned and Ready:lululemon Transitions, Canadian Business, April 24, 2006.

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employees were expected to learn what the values means to lululemon, but also to reflect on what the
values meant to them, and how they would act on the values each day. In different functional areas,
such as manufacturing or design, employees were trained on what a particular valuesuch as
qualitymeant within their functional area. An especially important core value was fun. Employees
believed this was part of what kept the lululemon magic alive as the company grew. For example, to
generate a buzz around one of its store openings, lululemon announced that the first 30 people to
come into the storewhile nakedwould get a free outfit. Employees were energized by the fact that
they were doing serious business while also staying irreverent. Longtime employees were dedicated
to keeping a rebellious streak alive at the company.

The unique lululemon culture played a central role in creating a distinctive shopping experience too.
Retail store staff members were educators and shoppers were referred to as guests. As the name
implies, educators role was not to sell clothes but to educate customers about the technical features
of the garments. Part of lululemons vertical strategy was to ensure that guests understood the
difference between their $90 pair of lycra pants and a competitors $30 pair of lycra pantsif
lululemon sold in a wholesale environment, it could be all too easy for shoppers to erroneously
assume the pants were the same. In cases where educators came to lululemon from a traditional
retailer, they often had to un-learn conventional sales tactics since at lululemon, that idea was for
the garment to sell itself.

In order to supply stores with such high quality garments, lululemon embraced a culture of
prototyping and continuous improvement. Designers held focus groups with leading athletes and were
in frequent communication with store educators, so they could remain abreast of feedback that guests
were providing in the store fit rooms. In fact, store fitting rooms included supplies for educators and
guests to provide feedback on the garmentsimprovements to existing ones and suggestions for new
ones.

Structure

From its inception, lululemon was vertically integrated, managing the process of clothing design,
manufacture, and distribution to its retail stores. The stores were decentralized, and they were run by
managers who had been fully trained in the lululemon manifesto. These managers were empowered to
follow their own vision for their store. They constituted the core of the lululemon brand and culture.
Store managers were treated as owners and were supported by regional sales coaches who advised
them on issues like customer outreach and clothing displays. Because of the autonomy afforded to
store managers, sometimes they did thingsfor example, creating a too-risqu window designthat
lululemon headquarters felt did not represent the brand values. When this happened, store managers
were given feedback and held accountable. Their compensation was designed to reward
entrepreneurial behavior, but to discourage excessive risk-taking; 80% of their salary was fixed and
20% was variable. While the power vested in store managers made lululemon quite decentralized, the
company remained aligned through the culture, and through Wilsons communications.

New Partners, New Era

In 1999, lululemon had one store and its sales were just $200,000. By 2005, it had 33 stores and sales
were $100 million. Lululemon had funded its expansion entirely through free cash flow. All retail
stores were rented and the company maintained less than half a million dollars in long-term debt. In
2005, Wilson decided to sell 48% of lululemon to private equity firms Advent International and

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Highland Capital. They invested approximately $220 million Canadian dollars. After the sale, Wilson
owned 42% of the company and employees owned the other 10%.

Lululemon had great potential. First, it was vertically integrated, which meant that the company really
owned the brand from top to bottom. Second, the investors believed that lululemons products were
truly differentboth functionally and technicallyfrom other offerings on the market. This, when
coupled with an extremely knowledgeable and enthusiastic employee base, was seen as a key
differentiator. Third, the companys performance in Canada was nearly unprecedented; the sales per
square foot were extremely high. As such, lululemon was able to open new stores and quickly make
their invested money back. Fourth, despite the fact that lululemon only had 20 stores at the time, it
had a near cult-like following amongst customers and even employees.

As part of the sale, Wilson got to know former Reebok chief executive Bob Meers. Initially, Meers
was a candidate for the board, but Wilson asked him to be lululemons CEO. Wilson believed Meers
knowledge of the important US marketwhere lululemon hoped to expandand his extensive retail
and consumer experience would help take lululemon to the next level. Wilson also took confidence in
the fact that when Meers had tried to have Reebok enter the womens fitness market, it stumbled.
Wilson believed that Meers clearly wanted another shot and would be motivated to get things right
this time. With Meers agreeing to step into the CEO role, Wilson became the chief product designer
and chairman. Meers agreed because the role was a big equity opportunity; he was amazed at the
company Wilson had created.

Meers Takes Action

Meers took the CEO role in 2005, and his mandate was to grow the firm and take lululemon public.

Meers was a big company person, and it was quickly clear to him that the company he entered was
one without much infrastructure. He believed that taking the company to the next level would require
making sure we have the manufacturing, sourcing, logistics and distribution systems capable of
supplying our expansion goals. 7 With this, he got to work.

First, he brought new people onto the management team, as well as other employees to manage the
supply chain. He brought in a new production team and a new buying team. These people had
business acumen, but many longtime employees saw them as outsiders who didnt get what the
company was about.

Second, Meers also shifted control from the store managers to the headquarters, using financial
planning to direct operations. Now, quantitative skills and business experience became more valued
than fit with the lululemon culture.

Third, during Meers tenure, lululemon went from manufacturing 80% of its garments in Canada and
then selling primarily there to manufacturing offshore and selling in both Canada and the US. 8 As
such, the distribution system became much more complex. Stores had to order the right quantity of
garments to do demand forecasting, to properly price markdowns and to manage the retail assortment;

7
Bogomlony, L., Toned and Ready: lululemon Transitions, Canadian Business, April 24, 2006.
8
lululemon has never manged the feel of a do-gooder company, The Toronto Star, October 17, 2007.

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but sometimes, a particularly hot product would sell out in three days. Inventory management was
becoming increasingly importantequally as important as selling.

Fourth, Meers took a more aggressive stance on real estate, particularly in the US. While lululemon
had known the Canadian market extremely well, in the US, where lululemon was much less well-
known, it was tougher to pick the best locations. Lululemon targeted suburban rather than a mix of
urban and suburban locations, since suburban locations were the most profitable stores in Canada.
Lululemon quickly acquired stores in what ended up being high priced, low traffic locations.

Lululemon went public in July of 2007, raising nearly $350 million dollars. 9 As 2008 began, the
board assessed Meers progress. He had delivered on going public and improved lululemons short-
term returns. However, sales per square foot had dropped from $1,710 to $1,452 between fiscal year
2007 and 2008. Same store growth had stalled from 24% to 3%. And, inventory costs had risen.
Morale in the top management team was down, and longtime employees felt underappreciated.

The Next Transition: From Meers to Day

The board believed that Meers had accomplished what he had set out to do, but they felt it was time
for a change. In early 2008, they tapped Christine Day, a Starbucks veteran, to be the next CEO.
Meers stepped down from the CEO role in mid-2008, and Day took over ahead of schedule. While
Day had never been a CEO before, she was an attractive candidate because of her work in creating
unique customer experiences at Starbucks and scaling that company, and because of her affinity with
the lululemon brand and culture. She quickly won the respect of Wilson. He believed she understood
what it would take to grow, but also had experience in understanding the pitfalls that firms like
lululemon could fall into.

But like Meers, Day had an aggressive mandate: make lululemon a billion-dollar company, all while
working to restore its internal health. Down the road, Day also had to make decisions about
expanding to foreign markets like China. In the short term, Day had to right the downward trends in
same store sales and sales per square foot, and figure out how to keep inventory costs down.

While pondering these short and long term issues as she worked the cash register early on a Sunday
morning in June of 2008, Day asked herself how to quickly grow lululemon while retaining its special
spirit; that was the billion dollar question.

9
Alexander, D., lululemon Shares Rise in First Trading Day After IPO, Bloomberg, July 27, 2007.