Can Struggling Abercrombie & Fitch Cash In on Cool Again?

At Abercrombie and Fitch's (ANF) flagship store in New York City, time seems to be standing still.

Outside, there is a black velvet rope and, often as not, a line stretching down the sidewalk. One-by-one, customers (many of them foreign tourists) pass through a doorway that is flanked by topless male models, their tastefully-tousled hair and rippling abs suggesting a teeny-bopper's vision of Chippendale's or Studio 54. Inside, low light and throbbing music fight for airspace with the fruity-floral scent of cologne and the tang of teenage pheromones.

It may not be the ideal environment for picking out clothes, but Abercrombie is about more than henleys and polos, khakis and t-shirts. It's about a philosophy, a lifestyle, and, perhaps, a little bit of eugenics.

But the buzz surrounding the company's flagship store in New York is not indicative of what can be found at the Abercrombie & Fitch stores in malls across America. While the A&F ethos ruled the American retail landscape for much of the past decade, its idealized version of perpetual youth has worn thin among cash-strapped consumers, threatening the company's sales, stock price, and future prospects.

Cool Kids in the Crosshairs

Abercrombie president Michael S. Jeffries is unapologetic about his ideal consumer. In an interview with Salon.com, he described his audience: "Candidly, we go after the cool kids ... A lot of people don't belong [in our clothes], and they can't belong. Are we exclusionary? Absolutely. Those companies that are in trouble are trying to target everybody: young, old, fat, skinny. But then you become totally vanilla. You don't alienate anybody, but you don't excite anybody, either."

But being cool comes with a price, and Abercrombie's clothes cost about twice as much as those of competitor American Eagle (AEO). Over the past two years, this has become a big problem for A&F, which has refused to follow in the footsteps of its competitors and adjust its business model and product line to accommodate more conservative consumer spending. Since 2008, even high-end companies like Nordstrom (JWN), Coach (COH) and Barney's have started to offer steep discounts, developing cheaper product lines, and opening outlet stores. But while other luxury retailers have desperately moved to become more profitable, Abercrombie took the road less traveled: Refusing to lower prices or accommodate strapped consumers. Abercrombie, it seemed, became the store that wouldn't bend.

Slowing the Slowdown

Fast forward a year, and Abercrombie is in trouble. Between 2008 and 2009, same-store sales dropped by 30% as inventory built up and customers to cheaper competitors like Aeropostale (ARO), Gap (GPS) and American Eagle. Finally, facing plunging profits and tumbling share price, Abercrombie blinked and began seriously discounting its clothes. In June 2009, the company shuttered Ruehl, its post-collegiate clothing brand. This year, Abercrombie took the next step, announcing plans to close 110 U.S. stores by the end of 2011.

Such moves have stopped the bleeding: same-store sales are up 5% over last year, and some analysts have placed Abercrombie stock on their buy lists. However, deep discounts have cut into the retailer's profit margin. Plus, the company's inventory is still up 47% over last year -- a worrisome development that caused the company's share price to drop 14% over the past three months.

Bad Press and Bloodsuckers

Although Abercrombie's bottom line is still hurting, the throbbing beat of the Abercrombie look continues to soldier on. Yet even style -- the store's stock in trade -- comes with its own set of worries. In September 2009, a Muslim teen in Tulsa, Oklahoma sued the chain for refusing to hire her because of her hijab, a ritual headscarf that she wore; she was later joined by another Muslim woman, California's Hani Khan, who was fired for wearing a hijab. In 2007, LaKettra Bennett, a Pentecostal woman in St. Louis, sued the company for firing her over her refusal to wear short skirts, while Britain's Riam Dean claimed that she was "banished to the back room" because her prosthetic arm didn't fit the company's strict dress code.

And if these public relations nightmares aren't enough to keep Abercrombie's executives up at night, the company's bedbug problem seems custom-made to create more than a few terrors. In July, the company closed its flagship Hollister store in New York City after employees repeatedly complained about a bedbug infestation. Later that month, the chain also shuttered one of its Abercrombie stores in the city for the same reason. Bedbugs only breed and feed after dark, but the company's low light apparently convinced the bloodsuckers that it is always party time at Abercrombie and Fitch.

Now, let's see if customers agree.