Zara case free essay sample

Inditex, founded by Amancio Ortega, operates six different chains: Zara, Massimo Dutti, PullBear, Bershka, Stradivarius, and Oysho. Zara is a leading apparel chain with major dominance in Spain. Zara being responsible for around 80% of Inditex’s gross profits is critical for Inditex’s growth. Currently, Zara is facing a convoluted problem of growth expansion both within and outside Spain. Within Spain, growth options for Zara seem limited owing to the already saturated market. Zara however has placed its foot in the Italian market (which it finds particularly lucrative owing to the fashion-forward Italian market) through a joint venture with Percassi and plans to add around 70 stores in the next decade. Other options for entry could be USA, Asia and other parts of Europe. The analyses focus on Zara’s business model and competitive advantages and depicts how it impact’s Zara’s growth. Vertical integration, delayed production, just-in-time manufacturing, and proactive design teams are some of the key features in Zara’s business model which makes Zara a competitive brand. With such peculiarities in its business model Zara has been able to maintain low failure rates as well as manage high operating efficiencies as compared to some of its competitors in Spain. Harnessing the Quick Response (QR) technique quite remarkably, Zara has drastically reduced its cycle times with minimal bullwhip effects. As a global apparel firm, Inditex’s main development strategy for international expansion is to become the sole or majority shareholder. However, for small or culturally different markets, it extended franchising agreements to leading local retail companies. For countries with large barriers to entry and an appealing customer base, Inditex created joint ventures with the possibility of later buying out its partner. Despite the different approaches used to enter into the international market, Zara has shown that there is no impediment to sharing a single fashion culture. It can be concluded that, with such valuable set of resources and capabilities which Zara possesses, it makes sense to grow into markets in which Zara can exploit its capabilities to the fullest. The move into the Italian market fits perfectly into Zara’s paradigm of effective Quick Response and is a laudable one. Also, entry into United States of America should rather be avoided at this stage as the American market is relatively backward as compared to fashion and Zara won’t be able to do justice to its capabilities as they could be rendered useless. Thus in order to undergo a sustainable growth, Zara should focus on partnering in geographies where its capabilities are complemented. Introduction In general, fashion apparel has highly volatile demand with high margins for the ‘in demand’ fashion products and heavy markdowns for ‘out of demand’ (outdated) products. Life cycles are short and unpredictable. It is a very tough job to predict what will be in trend and its demand. On the scale of functional-innovation products, fashion apparel is clearly on innovation end of spectrum. For an innovative product like fashion clothing, it is very important to provide the correct product variety not in terms of the number of options but more so in terms of the correct fashion. The efficiency considerations of the physical function are secondary to the above. Suppliers need to be chosen for their speed and flexibility and not just costs. It is important to decide where to position inventory in the supply chain to hedge against changing tastes and obsolescence. Reaction time to changes in demand pattern has to be swift. The correct response to an innovative product is therefore a responsive supply chain. The fashion apparel however also has the added dimension of being highly labour Demand Uncertainty Low High intensive especially when it comes to stitching. As per Lee’s Supply Low Zara framework, the demand is uncertain but supply is largely Uncertainty High certain and there is little variation to be expected in the supply of commodities like zippers, undyed cloth and buttons. Zara’s business model Zara’s business model is unique. In this analysis we tried to bring together the different features that actually make their business model unique. Distinctive Features of Zara’s business model 1. Just-in-time manufacturing system: Zara invested heavily in manufacturing logistics and IT and focused on development of internal manufacturing system for its fashion-sensitive products (40%). It also went for vertical integration of its production which helped it to supply new designs in about 4-5 weeks and restocking within 2 weeks. This was much better than industry standard of 6 months for design and 3 months for manufacturing. (Pg 9) 2. Delayed production: Since it has very less cycle time, Zara is able to delay much of its design, purchase and production decisions till the season has started as compared to traditional retailers. This way it is able to adjust to the latest trends of the season and come out with better suited products (Pg 9 and Exhibit 13 More about this in ‘vertical integration’ section) 3. Selling, General and Administrative Expenses: Zara’s SGA costs amount to only 20% of revenues whereas others maintain relatively higher costs. The only competitor to have cycle times close to Zara, i. e. , World Co. , has 40% of revenues allocated to these costs. 4. Design: Designers, product development personnel and store managers work in great coordination with each other. The Zara’s design teams continuously track customer preferences and use this information about sales potential based on a consumption information system to transmit repeat orders and new designs to internal and external suppliers. The design teams are bridged merchandising and the back end of the production process. Out of all designs, only those designs went into production for which consumer responses were positive. This way failure rates for the products was as low as 1% as compared to industry standard of 10%. (Pg 10) 5. Distribution: Zara followed its own centralized distribution system with main 400,000 m2 facility in Artexico and smaller satellite centres in Argentina, Brazil and Mexico. Zara has also started to schedule shipments by time zone. Due to one single location of centralized distribution facility, Zara faced diseconomies of scale. Hence it opened another facility near Madrid with well connected air, rail and road networks. (Pg 11-12) 6. Merchandising and media advertising: Zara with its high turnaround created a feel of freshness and scarcity in the stock material. This lures customers to buy at the earliest possible. This also results in low marked down inventory (for Zara it was around 15-20% as compared to European average of 3040%). Also much of the focus was given on the ambience of the stores. Stores were chosen in prime locations and were refurbished every 3-4 years to give new and fresh look. Zara also spent just 0. 3% of its revenues on media advertising as compared to 3-4% by others. This was done so as to create an atmosphere of exclusivity in the market and to avoid overexposure. (Pg 13-14) 7. Pricing: Prices, determined centrally, were lower than competitor’s for comparable products in the market. They were able to maintain this competitive edge in the market and have good percentage margins as they had efficiencies in the supply chain and their marketing and markdown requirements were low. 8. International market: Zara had rapid expansion during the period 1999-2001 wherein it opened chains in 24 countries as compared one country per year from 1992 to 1997. In comparison, HM added just 8 countries from 1980s to 2001. Zara laid focus on market costs rather than own costs for forecasting the prices in a particular market in consideration. This gave them a better idea of the issues and potential in the local markets and they were able to assess market profitability better than their competitors. For market entry, Zara initially used company-owned stores only but as the business expanded with limited resources, it also used the other two modes of expansion, i. e. , joint ventures and franchises. While franchises were used in less risky countries, JVs were used in the markets where barriers to entry were higher. (Pg 15) 9. Marketing: In general, all the countries had similar business arrangements but few local variations were allowed to capture regional aspirations. Zara opened first flagship store in a country and after gaining some experience expanded its span in that country and nearby countries. The international pricing differed from country to country based on the brand positioning and people’s capacity to buy in that country. This way, Zara was able to maximize its profitability while targeting correct market segments. (Pg 17-18) Comparing Zara with the average retailer with similar prices From exhibit 5 we can see that Zara and HM have comparable prices (Appendix B has detailed calculations) Comparing Zara one-on-one with HM, we can infer following points: a. Although asset turnover of HM is higher than Zara, Zara has higher sales to current assets ratio. This implies that Zara has highly mobile revenue system and it is efficient in utilizing its assets to generate revenues. The reason for low asset turnover is that HM outsources its entire production and therefore has much lower level of fixed Metric HM Inditex Zara assets. Asset turnover 2. 0 1. 2 1. 2 Sales to current assets ratio 2. 9 3. 8 3. 8 b. Similarly, though ROA of HM is higher than Zara, Zara is much higher than HM in ROA 18. 9 13. 1 15. 5 terms of operating and net margins. This Operating margins 13. 8 21. 7 21. 7 indicates that Zara’s process in much more Net margins 9. 7 10. 5 12. 4 Average Sales / store 5. 5 2. 5 4. 9 efficient than HM’s. -3 Average Sales / square metre (*10 ) 4. 61 4. 92 9. 51 c. Due to large sizes of the stores of HM, average sales/store is higher for them but if we look at average sales/ square metres Zara again takes a lead over HM. From the above points, we can easily conclude that Zara is more operationally efficient than its competitor in similar price category. Comparing the average retailer and Zara on the basis of sales price, manufacturing costs, advertising nd mark downs: Manufacturing Costs: From Exhibit 3, Zara’s cost of manufacturing is 20% more than Asia (=1. 2*29. 09=34. 9). Zara manufactures 40% in house, another 40% in Europe and 20% in Asia. The manufacturing mix of the average retailer varies around 0 to 40% in Europe and rest from Asia. Media Advertising Costs: Only 0. 3% of Zara’s revenue is spent on media advertising compared with 3%-4% for most speciality retailers. Advertising is limited to the start of sales period at the end of the season in the case of Zara. Items % for Zara Amount % for Others Amount Manufactured in Spain 40% 42. 24 0% 42. 24 Manufactured in Asia 20% 29. 09 50% 29. 09 Manufactured in Europe and North America 40% 34. 91 50% 34. 91 Weighted average 36. 68 32. 00 Sales Price (twice the manufacturing cost) 73. 35 73. 35 Advertising Costs 0. 30% 0. 22 3% 2. 20 SGA Costs 20% 14. 67 30% 22. 01 Profit 21. 79 17. 15 We can see that in the case Zara is profitable on a per item basis. Quick Response Policy QR policy is targeted towards improving coordination between retailing and manufacturing arms of the firm. The increased flexibility to market condition changes made QR policy the most sought after one in the apparel industry exposed to dynamic market conditions. The reduction in cycle time by implementing QR was tremendous. However certain geographical, functional and organisational changes were very much essential for harnessing QR which could help retailer forecast better, reorder frequently and probe the market. The table below depicts the how Zara undertook the changes as compared to World Co. Japan. Zara ? Integrated backward into domestic manufacturing ? Creative product development team which interacted with people across departments (sales, stores) frequently thus relying on high frequency information ? Proactive participation in study of customer demand through the information system present. ? Limited volumes of products (small) presented to customers to gauge preferences and use that information for bringing about changes if any in the subsequent batches. ? Product development personnel chosen from the country where they had to interact with stores. Impact: ? High flexibility in the supply chain ? Failure rates on new products for Zara were 1% as compared to 10% for the sector World Co. Japan ? Integrated backward into domestic manufacturing. ? Low emphasis on design. ? Japanese market relatively depressed than Europe hence probably there was less incentive to implement QR. Impact: ? Unnecessary administrative expenses impacting its revenues badly. ? Diminished net margins (2% of sales) as compared to Zara (10% of sales) Thus, it is evident that Zara’s proactive cross-functional working and effective use of high frequency information translating into reduced failure rates and posed a high competitive advantage. Vertical Integration Apparel industry is a characterized by a buyer-driven supply chain which needs to be more vertically integrated than producer-driven chains, because producer-driven chains are dominated by upstream manufacturers. However in apparel industry the downstream retailers play a very significant role. Zara is a vertically integrated company that owns different levels of the supply chain. From manufacturing to warehouse to retail outlets, Zara owns all of these different entities. This allows Zara to globally optimize instead of locally. This type of centralized decision making reduces the bullwhip effect on the overall supply chain. Information is also centralized allowing permeability amongst the different layers in the supply chain. Vertical integration is necessary for Zara if it wishes to continue with its highly responsive supply chain. (There is however an alternative of locking in highly trustworthy suppliers who can provide similar services. ) The efficient interactions between the retailing and the manufacturing arms (necessary for QR) have been possible for Zara because of its vertical integration. Because of the vertically integrated structure and one firm model they were able to carry out geographical, organizational and functional changes and were able to bring down the lead time from 6 months to about 6 weeks (Exhibit 4). Zara placed more emphasis on using backward vertical integration to be a very quick fashion follower. They were able to start with a new design and have finished goods in stores within 4 to 5 weeks and in 2 weeks for modifications (or restocking) of existing products. In comparison, the traditional industry model involved long cycles of up to 6 months for designing and 3 months for manufacturing. The shorter cycle time reduced the working capital intensity and facilitated continuous generation of new merchandise. It also allowed them to commit to bulk of its product line for a season much later than competitors (which was one of the main problems of the Sports Obermeyer Case). Thus, Zara undertook 35% of product design and purchases of raw material, 40%–50% of the purchases of finished products from external suppliers, and 85% of the in-house production after the season had started, compared with only 0%–20% in the case of traditional retailers (Pg 9). However, Zara’s vertical integration strategy is not entirely without its drawbacks. With having only few manufacturing facilities, Zara is unable to take advantage of economies of scale in order to produce a large amount of apparel for a relatively cheap unit price. Also, with Zara’s high replenishment rate of store selections, it needs to invest in highly flexible machinery and very skilled workforce in order to produce apparel in a quick and efficient manner. Production costs (machinery and labor) are relatively high for Zara’s supply chain compared to their competitors. Challenges Manufacturing and warehouse locations: Zara’s faces competition in its home market largely from HM which competes with Zara by providing lower prices with lesser variation. One of the biggest challenges for Zara is that they have concentrated everything right from their central warehouse, headquarters and factories in a corner of Europe in Galicia, Spain. This means that their costs and prices steadily increase as Zara moves further into Europe. Supporting this argument (Exhibit 15) the price of a Zara shirt shoots to 1. 5 times by the time it reached north Europe or Denmark. Germans are stated as being highly price conscious customers. A new firm in fashion apparel can utilize Germany as a base; follow Zara’s strategy of rapidly adapting to fashions and beat Zara heavily on prices. Germans are expensive as a labour force but one can then utilize cheaper locations in Eastern Europe like Poland which though not specified but are bound to be cheaper. This issue is also seen in Japan where they are bringing manufactured items from Spain even though China is next door and is a very low cost location. In any future expansion, they should look at setting up other hubs both within and outside Europe. Aggregation and transportation costs: Another problem is that they ship every item and receive all deliveries in their central warehouse in Arteixo. No strategy for bundling together demanded items has been described and with store deliveries every two weeks, transport costs will shoot up as distance increases making expansion of Zara unprofitable. Expansion into new markets is needed if Zara wishes to achieve the 20% revenue growth rate as the Spanish market which Zara is expected to dominate based on its location advantage, will saturate soon (HM could hit a high of 10% only in Sweden before declining). To achieve profitable revenue growth in other future hubs, Zara needs to recreate its Galician hub in other locations or break down the hub strategy and spread out production and distribution. Recommendations Inditex should focus its energy on its current chains, specifically Zara since this chain in particular is responsible for much of Inditex’s success. The move into the Italian market fits perfectly into Zara’s paradigm of effective Quick Response and is a laudable one. Also, entry into United States of America should rather be avoided at this stage as the American market is relatively backward as compared to fashion and Zara won’t be able to do justice to its capabilities as they could be rendered useless. Thus in order to undergo a sustainable growth, Zara should focus on partnering in geographies where its capabilities are complemented. Zara should also consider decentralising its manufacturing facility to locations located optimally from its new markets and consider places with low cost of manufacturing and labour (China and South Asia for Asian and European markets and Mexico for US market – if Inditex wants to still move into US market). Appendix 1: Apparel value chain (Source: Appelbaum and Gereffi (1994)) Appendix B: Detailed Computations HM Inditex Zara Gap Benetton Net Operating Revenues 4269. 0 3250. 0 2477. 0 15559. 0 2098. 0 COGS 2064. 0 1563. 0 1191. 2 10904. 0 1189. 0 Gross Margin 2205. 0 1687. 0 1285. 8 4656. 0 909. 0 Operating Expenses 1615. 0 982. 0 748. 4 4276. 0 624. 0 Operating Profits 590. 0 705. 0 537. 3 379. 0 286. 0 Non-operating Expenses -28. 0 209. 0 96. 3 108. 0 43. 0 Pre-tax Income 618. 0 496. 0 441. 0 272. 0 243. 0 Income Tax 206. 0 150. 0 133. 4 280. 0 92. 0 Minority Interests 0. 0 5. 0 0. 0 2. 0 Net Income 412. 0 341. 0 307. 6 -9. 0 148. 0 Current Assets 1468. 0 854. 0 650. 9 1468. 0 1558. 0 Assets 2183. 0 2605. 0 1985. 4 8566. 0 2821. 0 No. of stores 771. 0 1284. 0 507. 0 3097. 0 5456. 0 Avg. Store size in sq. mt. 1201. 0 514. 0 514. 0 632. 0 279. 0 Asset turnover 2. 0 1. 2 1. 2 1. 8 0. 7 Sales to current assets ratio 2. 9 3. 8 3. 8 10. 6 1. 3 ROA 18. 9 13. 1 15. 5 -0. 1 5. 2 Operating margins 13. 8 21. 7 21. 7 2. 4 13. 6 Net margins 9. 7 10. 5 12. 4 -0. 1 7. 1 Average Sales / store 5. 5 2. 5 4. 9 5. 0 0. 4 Average Sales / square metre (* 10^(-3)) 4. 61 4. 92 9. 51 7. 95 1. 38 Ratio of revenues Ratio of revenues