The Canadian Broadcasting Corp. reported Saturday the U.S. company yanked the costume, which featured a short animal hide dress, feather headband, beaded necklace and pink leggings.
An Incharacter representative said the company didn't know the term "squaw," which is believed to be derived from the Algonquian word for woman, has come to be considered demeaning and offensive by many Indians.
"We have admitted our error and issued apologies to anyone and everyone who has contacted us," the company told the CBC in an email statement.
"We pulled the style off our website and we are discontinuing this style for future production. In addition, we are taking action to contact any retailers who may still have this product on their shelves to request that they remove the packaging with the name from their stores."
The costume was being sold at Sears.com and on Amazon.ca, the CBC said.
Gail Cyr of Yellowknife said activists have been trying to change stereotypical images of Indians and "This kind of stuff does not help."
"It gives a primitive view of what aboriginal girls and women are all about," she said.
Kathy Paul Dover told the CBC Indians "would never dress like that.
"Oh my God, are you serious?" Kathy Paul Drover said when she saw the costume. "It should be pulled immediately."