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Author: Pankaj Ghemawat, Jose Luis Nueno
Publisher: HBR
Case Number: 9-703-497
Publication Date: Apr 1, 2003
Course Category: Operation
Zara and the Global Apparel Industry
This case focuses on the Spanish retail giant, Inditex and how its largest retail chain Zara has been so successful through its simple business model of speed, flexibility, and high fashion. As of 2002, Inditex operated six separate chains: Zara, Massimo Dutti, Pull & Bear, Bershka, Stradivarius, and Oysho. Each chain operates independently and is responsible for its own strategy, product design, sourcing and manufacturing, distribution, image, personnel, and financial results. Zara is by far the largest, most profitable, and most internationalized of the chains. At the end of 2001, Zara operated 507 stores around the world (40% of Inditex), posted EBIT of 441M Euros (85% of Inditex), and sales of 2,477M Euros (76% of Inditex). Currently, H&M is Inditex’s major competitor. The ratio analysis below shows H&M and Inditex’s competitive standing in the industry.
Gap H&M Benetton Inditex
Net Margin -0.06% 9.60% 7.05% 10.46%
Asset Turnover 1.82 1.96 0.74 1.25
ROA -0.11% 18.78% 5.25% 13.05%
ROE -0.27% 24.85% 11.93% 22.88%
Zara’s success is based on a business system that depends on vertical integration, in-house production, quick response, one centralized distribution center, and low advertising cost all of which made it so successful thus far. Powered by Zara’s success, Inditex has expanded into 39 countries, making it one of the most global retailers in the world. But in 2002, it faces the important questions concerning its future growth. There were significant local variation in customers’ attributes and preferences across regions and countries, and Inditex faced tough competition internationally with companies including H&M, Gap, and Benetton. We will examine how Zara should grow in the face of the retail garment industry while maintaining its business model of fast fashion and flexibility.
Challenges
a. Limitations of Vertical Integration
Vertical integration, a distinctive feature of Zara’s business model, has allowed the company to successfully develop a strong merchandising strategy. This strategy has led Zara to create a climate of scarcity and opportunity as well as a fast-fashion system. However, Zara’s strategy creates some weaknesses. Their vertical integration has more advantages than drawbacks but it is important to recognize its limitations. Vertical integration often leads to the inability to acquire economies of scale, which means Zara cannot gain the advantages of producing large quantities of goods for a discounted rate. Higher costs are then incurred for the Inditex Corporation.
Inditex also has to support their own high capital investments for their chains and be able to financially back their “Technology and skills” beyond those currently available within the organization. Zara’s speedy and recurrent introductions of new products incur increased costs as well. They have higher research and development costs. They also have elevated costs due to the constant changeover of production techniques to create their different apparel lines. That also means that employees must be trained in order to use the new manufacturing techniques, which again leads to increased costs. Traditional retailers do not experience higher costs in all of these areas.
b. Diseconomies of scale: Zara has not invested in distribution facilities to support their global expansion. As a result, although it is aware of how to quickly supply 1,000 stores, they may not be able to supply more retail locations due to their “centralized logistic” model.
Even though Zara has been successful at scaling up its distribution system, the centralized logistics system might eventually be subject to diseconomies of scale as Zara continues to open stores all around the world and ships product from its single Distribution Center in Europe. This system may work well with the current number of stores because majority of the stores are centralized in Europe. However, Inditex won’t be benefiting from short lead times and low operational cost with a single central Distribution Center model as they are branching out into other countries.
c. Fast and recurring introduction of new products in different countries increase costs
R&D: In the manufacturing environment, Zara’s product development teams are responsible for attending high-fashion fairs and exhibitions to translate the latest trends of the season into their designs.
Also throughout the season, Zara’s product development teams are constantly researching the market by traveling to universities and clubs around the world to track customer preferences. Additionally, the young, fashionable, and international staff helps to interpret the desire of the moment (Zara).
Changeover of production techniques to create different apparel lines requires highly automated equipment specialized by garment type. The more flexible the system is, the more costly the production will be. In addition, employees need to be trained to use new manufacturing techniques
c. Developing vertically integrated supply chain system in different countries with high labor cost will result in high production cost
Zara Management is considering investing in distribution and production in new regions they are expanding into. North America and Asia seemed to be the obvious regional opportunities. The U.S market was subject to retailing overcapacity, demanded larger sizes on average. Zara is already in major cities in the United States. Since Zara does not have any distribution or manufacturing facility within United States, all the apparel is shipped from Europe to the States which incurs a significant transportation cost.
Recommendations
Short term
Renegotiate overseas shipping costs and terms.
Building new plants and equipment is very expensive and takes a lot of time so it may not be feasible to open up new manufacturing plants or distribution centers in America in the short term. Zara will need to continue to ship product from its European distribution center. Leveraging the fact that Zara’s shipments will grow as they continue to expand can help them renegotiate overseas shipping costs and terms to reduce overall costs.
Internet Retailing (America)
With an existing website in place, Zara can easily add the e-commerce feature to its website. Although 80% of trends and styles are common across all countries, there is still some variation in preference and taste from country to country. Zara can reach consumers faster and easier in the countries they are trying to expand into. This method can also help gauge consumer preferences from country to country.
Long Term
Build a central regional distribution center in America and smaller/satellite distribution centers in other countries
Zara maintains its competitive advantage in Europe through its fundamental concept to maintain design, production, and distribution processes that enable quick response to customer demand. Global expansion means that Zara needs to carry its business model to America in order to maintain short production and lead times. Building a central distribution center in America will help Zara decrease logistics and help maintain Zara’s model of fast fashion and economies of scale. Zara can strategically locate its central distribution center in or near countries where manufacturing can be done with cheap labor cost (i.e. Mexico or Carribeans). Smaller distribution centers or satellite centers should be built in countries where expansion will proliferate in order to shorten lead times. The close proximity of the distribution center to the American market will allow Zara to effectively interpret the particular American fashion.
The increased cost of product variety will increase cost due to possible changeover of production techniques to create different apparel lines but this cost is warranted since the monetary gain is much greater than the cost. Central distribution centers, however, will help cut some the cost of quick, high fashion since it can help streamline some of the processes and techniques used to create different apparel as they vary from country to country.
Implementations
To expand globally, Zara should focus on one country at a time. Our team concludes that United States should be Zara’s current focus on international expansion. United States is an open trade market with well formed trade regulations. This provides a safer business environment as compared to Asia countries. During the globalization process, Zara should maintain short lead time, quick inventory turnover, leading fashion brand and low advertising cost as its competitive advantage. Regional distribution center, vertical integration, outsourcing, eye-catching window displays are the key elements for Zara to continue to re-invent and innovate themselves to stay fresh in the apparel industry. Below you may find the implementation details for United States region:
Retail – In the short run, invest in prime locations in major cities such as New York, Chicago, Washington DC, Seattle and Los Angeles. These leading fashion cities within United States will assist Zara to establish its reputation and brand name in the United States. In the long run, Zara should continue invest in prime locations in different cities within United States as company owned stores; however, partnership is also consideration as a trade-off for location.
Design – Centralize in Europe with feedback from country/region managers. This allows Zara to maintain European style, at the same time, minimize design cost.
Distribution – In the short run, rely on the distribution center located in Europe. In the long run, build a central distribution center in Texas. This provides U.S. stores with shorter lead time.
Sourcing & Manufacturing – Use suppliers in the Mexico and Caribbean Basin to achieve lower labor cost. Further, Mexico and Caribbean Basin’s geographic location allows Zara to receive inventory within reasonable lead time.
Risks
Financial Risk – Investing in new stores, in house manufacture, and distribution center increases the risk of low working capital. External funding is also a risk Zara has to assume in order to expand. Currently, Inditex’s current asset to total liability ratio is .76, which is not too appealing as compare to H&M at 2.76. When compared to industry at .87, Inditex is also below the average.
Direct Competition – Expanding into new territories will pose new competitors. Because Zara offers such a wide variety of products (men, women, maternity, children, & baby) almost any apparel retailer can be a threat.
Although financial and direct competition are major risks facing Zara’s expansion, Zara’s ability to maintain short lead time, low production cost and fast fashion would mitigate the risk of failure in its efforts of global expansion.