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MGT301 Zara Case Study and Questions Help

The middle-aged mother buys clothes at the Zara chain because they are cheap, while her daughter aged in the mid-20s buys Zara clothing because it is fashionable. Clearly, Zara is riding two of the winning retail trends – being in fashion and low prices – and making a very effective combination out of it.

The poor, ship-building town of La Coruña in northern Spain seems an unlikely home to an innovator in the fashion industry, but that is where you will find ‘The Cube’, the gleaming, futuristic central command of the Inditex Corporation (Industrias de Diseno Textil), parent of game-changing clothes giant, Zara. The firm shuns advertising, rarely runs sales and in an industry where nearly every major player outsources manufacturing to low-cost countries, Zara is highly vertically integrated, keeping huge swaths of its production process in-house. These counterintuitive moves are part of a recipe for success that is leaving the competition guessing and that has turned the founder of Inditex, Amancio Ortega, into Spain’s wealthiest man and the world’s richest fashion executive.

The firm tripled in size between 1996 and 2000 then skyrocketed from $2.43 billion in 2001 to $13.6 billion in 2007. When Inditex offered a 23 per cent stake to the public in 2001, the issue was over-subscribed 26 times raising 2.1 billion euros for the company. By August

2008, sales edged ahead of Gap, making Inditex the world’s largest fashion retailer. While the firm supports eight brands, Zara is unquestionably the firm’s crown jewel and growth engine, accounting for roughly two-thirds of sales. While competitors falter, Zara is undergoing one of the fastest global expansions the fashion world has ever seen, opening a store a day and entering new markets worldwide – 77 countries by 2009. The chain’s profitability is among the highest in the industry. The fashion director for luxury goods maker LVMH calls Zara ‘the most innovative and devastating retailer in the world’.

An unconventional formula

Buy low, sell high. Buy on credit, sell on cash. Retail profitability often seems like a no- brainer. As long as your operating and financial costs are lower than the gross margin, you should be making money; and when retailers run around with gross margins of 50 to 60 per cent (that is more than half of their retail price), making money should be no problem, right?

Wrong. In highly perishable goods such as fashion products that are susceptible to seasons, gross margin is meaningless if the product does not sell as planned. In simple terms, you make more money if you sell more, even at a lower margin. Thirty per cent on sales of $100 products selling fast is better than sixty per cent on products that sell more slowly. This is so because, given the unpredictability in fashion, it is quite likely that you will end up selling a large proportion of your products at a discount. For many retailers, 35 to 40% of the total merchandise being sold at hefty discounts is quite the norm. Imagine fashion clothing to be like vegetables, or bread. On the first day it looks very appetising and has lots of buyers. By the second and third day it starts to look stale, but customers may still pick it up, maybe at lower prices. By the time a week is over, the retailer is probably better off giving the bread away just to clear up space. This is why Inditex Chief Executive José María Castellano is quoted as saying, ”This business is all about reducing response time. In fashion, stock is like food. It goes bad quick.”

Zara’s products look like high fashion, but are comparably inexpensive. A Goldman analyst has described the chain as “Armani at moderate prices” while another industry observer suggests fashions are more ‘Banana Republic’, prices are more ‘Old Navy’. Offering clothing lines  for  women,  men  and  children,  legions  of  fans  eagerly  await  ‘Z-day’,  each  Zara location’s twice-weekly inventory delivery that brings in the latest designs.

Dont guess – collect data

How do you make sure stores carry the kinds of things customers want to buy? Try asking them.   Zara’s   store   managers   lead   the   intelligence  gathering   effort   that   ultimately determines what ends up on each store’s racks. Armed with handheld personal digital assistants (PDAs) to gather customer input, staffs regularly chat up customers to gain feedback on what they’d like to see more of. A Zara manager might casually ask: What if this skirt were in a longer length? Would you like it in a different colour? What if this v-neck blouse were available in a round-neck?

Another level of data gathering starts as soon as the doors close. Then the staffs turn into a sort of CSI in the forensics of trend-spotting, looking for evidence in the piles of unsold items that customers tried on but didn’t buy. Do there seem to be any preferences or disappointment in cloth, colour, or styles offered among the products in stock?

PDAs are linked to the store’s point-of-sale system, showing how garments rank by sales. In less than an hour, managers can send updates that combine the hard data captured at the cash  register combined  with  insights  on  what customers  would  like  to  see.  All  of  this valuable data allows the firm to plan styles and issue re-buy orders based on feedback rather than hunches and guesswork. The goal is to improve the frequency and quality of ‘sense making’ for the design and planning teams.

Design

Rather than create trends by pushing new lines via catwalk fashion shows, Zara prefers to follow with designs where there’s evidence of customer demand. Data on what sells and what customers want to see goes directly to ‘The Cube’ in La Coruña, where teams of some 300 designers crank out an astonishing 30,000 items a year versus 2,000-4,000 items offered up at big chains like H&M (the world’s third largest fashion retailer) and Gap. While H&M has offered lines by star designers like Stella  McCartney and Karl Lagerfeld, as well  as celebrity collaborations with Madonna and Kylie Minogue, the Zara design staffs are mostly young, hungry Project Runway types fresh from design school. There are no prima donnas in ‘The Cube’.

In the fickle world of fashion, even seemingly well-targeted designs could go out of favour in the months it takes to get plans to contract manufacturers, tool up production, then ship items to warehouses and eventually to retail locations. But getting locally targeted designs quickly  onto  store  shelves  is  where  Zara  really  excels.  In  one  telling  example,  when Madonna played a set of concerts in Spain, teenage girls arrived to the final show sporting a Zara knock-off of the outfit she wore during her first performance. The average time for a Zara concept to go from idea to appearance in store is 15 days whereas rivals often receive new styles only once or twice during a season. Smaller tweaks arrive even faster. If enough customers come in and ask for, say a round neck instead of a v-neck, a new version can be in stores with in just 10 days. To put that in perspective, Zara is twelve times faster than Gap, despite offering roughly ten times more unique products. Contrast this with H&M, where it takes three to five months to go from creation to delivery – and they’re considered one of the best. Other retailers need an average of six months to design a new collection and then another three months to manufacture it. VF Corp (Lee, Wrangler) can take 9 months just to design a pair of jeans, while J. Jill needs a year to go from concept to shelves. At Zara, most of the products you see in stores didn’t exist three weeks earlier, not even as sketches.

This is made possible thanks to supply chain integration and close coordination of suppliers, just-in-time manufacturing and finely-tuned logistics. While H&M has 900 suppliers and no factories, nearly 60% of Zara’s merchandise is produced in-house, with an eye on leveraging technology in those areas that speed up complex tasks, lower cycle time and reduce error. Profits from this clothing retailer come from blending math with its data-driven fashion sense. Inventory optimisation models help the firm determine how many of which items in which sizes should be delivered to stores during twice-a-week shipments, ensuring stores are stocked with just what they need. Outside the distribution centre in La Coruña, fabric is cut and dyed by robots in 23 highly automated factories. Zara is vertically integrated: the firm makes 40% of its own fabric and purchases most of its dyes from its own subsidiary. Roughly half of the cloth arrives undyed so the firm can respond as any mid-season fashion shifts occur. After cutting and dying, many items are stitched together through a network of local cooperatives that have worked with Inditex so long they don’t even operate with written contracts. The firm does leverage contract manufacturers (mostly in Turkey and Asia) to produce staple items with longer shelf lives, such as t-shirts and jeans, but this volume accounts for only about 1/8th of dollar volume.

All of the items the firm sells end up in a 5 million square foot distribution centre in La Coruña, or a similar facility in Zaragoza in Spain’s northeast. The La Coruña facility is some nine times the size of Amazon’s warehouse in Fernley, Nevada, or about the size of 90 football fields. The facilities move about 2.5 million items a week, with no item staying in- house for more than 72 hours. Ceiling-mounted racks and customized sorting machines patterned on equipment used by overnight parcel services whisk items from factories to staging areas for each store. Clothes  are  ironed in advanced, packed on hangers, with security and price tags affixed. This means that instead of wrestling with inventory during busy periods, employees in Zara stores simply move items from shipping box to store racks, spending most of their time on value-added functions like helping customers find what they want. Efforts like this help store staff regain as much as three hours in prime selling time.

Trucks serve destinations that can be reached overnight, while chartered cargo flights serve farther destinations. The firm recently tweaked its shipping models through Air France-KLM Cargo and Emirates Air, so flights can coordinate outbound shipment of all Inditex brands with return legs loaded with raw materials and half-finished clothes items from locations outside of Spain.

Stores

Most products are manufactured for a limited production run. While running out of bestsellers might be seen as a disaster at most retailers, at Zara the practice delivers several benefits.

First, limited runs allow the firm to cultivate the exclusivity of its offerings. While a Gap in L.A. carries nearly the same product line as one in Milwaukee, each Zara store is stocked with items tailored to the tastes of its local clientele. A Fifth Avenue shopper quips “At Gap, everything is the same”, while a Zara shopper in Madrid says “you’ll never end up looking like  someone  else”.  Upon  visiting  a  Zara,  the  CEO  of  the  National  Retail  Federation marvelled “It’s like you walk into a new store every two weeks”.

Second, limited runs encourage customers to buy right away and at full price. Savvy Zara shoppers know the newest items arrive on black plastic hangers, with store staff transferring items to wooden ones later on. Don’t bother asking when something will go on sale, if you wait three weeks the item you wanted has almost certainly been sold or moved out to make room for something new. Says one 23-year old Barcelona shopper “If you see something and don’t buy it, you can forget about coming back for it because it will be gone”. A study by consulting firm Bain & Co. estimated that the industry average markdown ratio is approximately 50%, while Zara books some 85% of its products at full price. The constant parade of new, limited-run items also encourages customers to visit often. The average Zara customer visits the store 17 times per year, compared with only three annual visits made to competitors.   Even   more   impressive,  Zara   achieves   these  numbers   with   almost   no advertising. The firm’s founder has referred to advertising as a “pointless distraction”. The assertion carries particular weight when you consider that during Gap’s collapse, the firm increased advertising spending but sales dropped. Fashion retailers spend an average of 3.5% of revenue promoting their products, while ad spending at Inditex is just 0.3%.

Finally, limited production runs allows the firm to, as Zara’s CEO once put it “reduce to a minimum the risk of making a mistake and we do make mistakes with our collections”.

Failure rates of the chain’s product line are reported to be just 1%, compared with the industry average of 10%.

While stores provide valuable front-line data, headquarters plays a major role in directing in-store operations. Software is used to schedule staff based on each store’s forecasted sales volume, with locations staffing up, say at peak times such as lunch or early evening. The firm claims these more flexible schedules have shaved staff work hours by 2%. This constant refinement of operations throughout the firm’s value chain has helped reverse a prior trend of costs rising faster than sales.

Even the store displays are directed from ‘The Cube’, where a basement staging area known as ‘Fashion Street’ houses a village of bogus storefronts meant to mimic some of the chain’s most exclusive locations throughout the world. It is here that workers test and fine-tune the chain’s award-winning window displays, merchandise layout, even determine the in-store soundtrack. Every two weeks, new store layout marching orders are forwarded to managers at each location.

Gap versus Inditex (data in US$):

Gap Inditex
Revenue $14.7 billion $18.2 billion
Net income $1.2 billion $2.5 billion
Number of stores 3,246 5,044
Number of countries 31 77
Biggest brand Gap Zara
Number of other brands 4 7
First store opened 1969 1975

Moving forward

For nearly two decades now, Zara has delivered the goods. But that’s not to say the firm is done facing challenges.

Consider  the  limitations  of  Zara’s  Spain-centric,  just-in-time  manufacturing  model.  By moving all of the firm’s deliveries through just two locations, both in Spain, the firm remains hostage to anything that could create a disruption in the region. Firms often hedge risks that could shut down operations – like weather, natural disaster, terrorism, labour strife, or political unrest – by spreading facilities throughout the globe. If problems occur in northern Spain, Zara has no such fall-back.

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In  addition  to  the  operations  vulnerabilities  above,  the  model  also  leaves  the  firm potentially  more  susceptible  to  financial  vulnerabilities  as  the  Euro  has  strengthened relative to the dollar. Many low-cost manufacturing regions have currencies that are either pegged to the dollar or have otherwise fallen against the Euro. This means Zara’s Spain- centric costs rise at higher rates compared to competitors, presenting a challenge in keeping profit margins in check. Also of concern are increasing transportation costs. As fuel costs continue to rise, the model of twice-weekly deliveries that has been key to defining the Zara experience becomes more expensive to maintain.

Still, Zara is able to make up for some cost rises by increasing prices overseas (in the US, Zara  items  can  cost  40%  or  more  than  they  do  in  Spain).  Zara  reports  that  all  North American stores are profitable and that it can continue to grow its presence, serving 40-50 stores with just two US jet flights a week. Management has considered a logistics centre in Asia, but expects current capacity will suffice until 2013. A centre, say in the maquiladora region of northern Mexico, may also be able to serve the US markets via trucking capacity similar to the firm’s Spain-based access to Europe, while also providing a regional centre to serve growth throughout Latin America, should the firm continue its Western Hemisphere expansion.

Rivals have studied the firm’s secret sauce and while none have attained the efficiency of Amancio Ortega’s firm, many are trying to learn from the master. There is precedent for contract firms closing the cycle time gap with vertically integrated competition that own their own factories. Dell (a firm that builds its own PCs while nearly all its competitors use contract labour) has recently seen its manufacturing advantage from vertical integration fall as  the  partners  that  supply  rivals  have  mimicked  its  techniques  to  become  far  more efficient. In terms of the number of new models offered, clothing is actually more complex than computing, suggesting Zara’s value chain may be more difficult to copy. Still, H&M has increased the frequency of new items in stores, Forever 21 and Uniqlo get new looks within 6 weeks, Renner, a Brazilian fast fashion rival, rolls out mini-collections every two months and Benetton, a firm that previously closed some 90% of US stores, now replenishes stores as fast as once a week.

Finally, firm financial performance can also be impacted by broader economic conditions. When the economy falters, consumers simply buy less and may move a greater share of wallet to less stylish but even lower-cost offerings from deep discounters like Wal-Mart. Zara is particularly susceptible to conditions in Spain, since the market accounts for nearly 40% of Inditex sales. Global expansion will provide the firm with a mix of locations that may be better able to endure downturns in any single region.

Questions:

  1. 1. Carry out a value chain analysis of Zara.
  2. 2. Complete a SWOT analysis of Zara.
  3. 3. Propose high-level recommendations.

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