June 8 - Gap Inc will cut back on the number of cotton vendors it deals with and develop more direct relationships with mills as it tries to rein in soaring yarn and fabric costs, Chief Executive Glenn Murphy said on Wednesday.

United States apparel maker GAP Inc.'s new flagship store in the up-market Ginza shopping district in downtown Tokyo (Photo: Corbis)

Murphy also admitted at an investor conference that the clothing retailer made mistakes recently and said its flagship brand needs significant changes in North America.

Gap can get its operating profit margin back to the 2010 level of 13.4 percent "at some point in the near future," he added during a presentation to analysts in New York.

Gap slashed its full-year earnings forecast last month, sending its stock down more than 10 percent May 20.

On Wednesday, Murphy partly blamed that forecast on soaring cotton and yarn prices earlier in 2011. But he also said the company was partly at fault.

Gap's assumptions about the cost of goods for the second half of 2011 were too low and the company could have avoided some of the problems by buying more fabric earlier, Murphy said.

"Could we have done more with hindsight? Yes," Murphy said, explaining that the company is changing its strategy for buying material.

"We've got to look vendors straight in the eye and say we're cutting back," Murphy said. "We didn't do enough of it. To get the cost I believe the company should be getting, given its size."

The cost of goods, driven by cotton and yarn, will "definitely" come down over time. That should help Gap get back to its 2010 operating profit margin of 13.4 percent, Murphy said. Operating income in Gap's first quarter was $386 million, or 8.5 percent of $3.3 billion in net sales.

Gap is planning to slash the number of Gap-brand stores in North America to roughly 700 from 1150 currently, while opening more outlet stores, Murphy added.

This is part of a shift from a specialty retail focus to a value strategy, he noted.

"This is a business we know is in need of improvement," Murphy told analysts.

Also on Wednesday, Barclays Capital cut its rating on Gap to "equal weight" from "overweight." Analyst Stacy Pak said in a research note that, after meeting with Gap management, she was "not comfortable that there won't be further negative earnings revisions going forward."

Gap shares were down 2.1 percent at $17.53 on Wednesday on the New York Stock Exchange.

(Reporting by Alistair Barr; editing by Andre Grenon)