Okay, it's probably a massive overstatement to argue that Gap Inc. (NYSE: GPS) is going down in flames. However, there is little doubt that the once-ubiquitous brand is experiencing some serious problems. Between brand confusion, the decline of narrow-focus retailers, and increasing competition from other companies, Gap will either have to massively tighten up, or 2009 is going to be a rocky year.

The first problem lies with brand identity. Gap, Inc. owns three major retail chains: Gap, Old Navy, and Banana Republic. Although the Gap was, historically, a relatively inexpensive brand, it has forged out a mid-level space for itself. At this point, its customers expect well-constructed, durable, relatively classic styles. By comparison, Banana Republic focuses on more upscale clothing, and Old Navy sells cheap, relatively disposable clothes. To put it another way, Old Navy markets itself toward high school and college students, Gap markets towards college and young professional, and Banana Republic skews more toward young professional.

Obviously, these aren't hard and fast delineations, and there is considerable overlap among Gap's target demographics; however, this is basically the way that Gap splits up its customer demographic. The trouble is that the high prices that one may expect of Banana Republic have found their way down to the Gap, while the questionable construction that is perfectly acceptable at Old Navy somehow has migrated into many of Gap's garments. This brand confusion has resulted in overpriced clothing items that quickly fall apart. Not surprisingly, it has also led to some major irritation on the part of Gap's loyal customers.

Gap's second problem lies in the increasing irrelevance of malls. In the course of 2008, rising gas prices and inflation have emptied out malls, and many narrow-focus retailers have felt the pinch. It's not accidental that some of the year's biggest economic sob stories have been in this market, and the difficulties experienced by Sharper Image (OTC: SHRPQ), Linens 'N Things, Williams-Sonoma (NYSE: WSM), Wilson's The Leather Experts, and other predominantly mall-based retailers have definitely pointed to the danger of having a narrow focus and boutique prices when consumers are counting pennies. On the bright side, Gap's online sales have risen, helping to offset their same-store declines. To encourage this, Gap offers customers $7 flat-rate shipping and gives them the option of combining orders from all four of its stores (including Piperlime, a shoe retailer). However, a large part of Gap's appeal is the sensual touch of its merchandise. While online sales offer convenience and save gas, they rely, to a certain extent, on the physical interaction that customers have already had with the products.

Gap's final problem is that it is no longer the only kid in town. As Georges Yared noted a little more than a month ago, Spanish retailer Zara has copied key parts of Gap's model, with the added benefit of having multiple price points under one roof. Moreover, Zara (which is part of the huge distribution company Inditex, which trades on the Spanish exchange) has only begun to enter the lucrative American market and seems to be retaining the impressive cache that Gap once had. With this in mind, it's hardly surprising that Zara recently became the world's largest retailer, moving past Gap, Inc. Luckily, the weak American dollar is keeping Zara's prices out of the range of many consumers; on the other hand, it's also keeping consumers out of Gap's stores!

It's hard to tell what's next for Gap. If it can make clear delineations between its brands, shore up its customer base, and find a way to revitalize its brand, it might regain its top retail position. Failing that, it wouldn't be surprising to see a lot of former Gap customers sporting Zara bags in the next few years!