Zara: History And Background

Inditex is a global specialty retailer that designs, manufactures, and sells apparel, footwear, and accessories for women, men and children through its chains around the world. Zara is the largest and most internationalized of the six retailers that Inditex owns: (Zara, Massimo Dutti, Pull & Bear, Bershka, Stradivarius, and Oysho). By the end of 2001, Zara operated 507 stores around the world, including Spain.

Of Inditex’s total employees, over 80% of them are part of the retail sales force and 8.5% are in manufacturing, design, logistics, and distribution. The remaining 11.5% are part of the corporate headquarters of Inditex, which is located in the region of Spain called Galicia.

The role of the corporate center at Inditex’s headquarters is that of a “strategic controller” only, and is involved in setting the corporate strategy, approving the business strategies of the individual chains, and controlling their overall performance rather than as an “operator” functionally involved in running the chains. This gives Zara autonomy to operate independently and be responsible for its own strategy, product design, sourcing & manufacturing, distribution, image, personnel and financial results.

With this freedom, Zara was able to make major investments in manufacturing, logistics, and IT, including establishment of a just-in-time manufacturing system and a 130,000 square meter warehouse close to its corporate headquarters. Zara manufactured its most fashion-sensitive products internally and its designers continuously tracked customer preferences and placed orders with internal and external suppliers based on this information. Due to its unique needs, Zara chose to internally develop its business systems. Zara is now able to originate a design and have finished goods in stores within weeks for entirely new designs and take even less time for modifications of existing products.

Key International Competitors of Inditex

Gap, H&M and Benetton are considered Inditex’s three closest comparable international competitors. As in the product positioning map, Inditex’s flagship brand, Zara, is relatively perceived as more fashionable than all the other three and prices less than Benetton and Gap but higher than H&M. In these four competitors, Benetton and Gap place at relatively less fashionable and higher price, while Zara and H&M is more fashionable and price lower.

In Appendix 1 which analyzed the operating and financial performance of the 4 companies in the year of 2001, we can see that H&M is the closest competitor in many dimensions, such as ROE, Gross and Net Profit Margin, etc. Also, H&M’s focused approach to international market is more similar to Inditex’s expansion style than the other two closest competitors.

Business Model of Zara

As the largest and most internationalized brand of Inditex’s chain, Zara is the principle driver of the group’s growth and play the lead role of Inditex’s sales and profit. Zara’s unique business model brings special interest of business studies and is often sited as “Dell in the fashion industry”.

The core concept of Zara’s business model is they sell “medium quality fashion clothing at affordable prices”, and vertical integration and quick-response is key to Zara’s business model. Through the entire process of Zara’s business system: designing, sourcing and manufacturing, distribution and retailing, they presented four fundamental success factors: short cycle time, small batches per product, extensive variety of product every season and heavy investment in information and communication technology. These four elements are involved in every aspect of the business.

Zara’s designers track consumer preferences on a year-round basis and place orders with both internal and external designers. Each year several hundred thousand SKU’s are produced based on 11,000 distinct items varying in color, fabric and size. Zara is able to accomplish this huge variance due to ordering small batches and internal production of the most stylish, and therefore most time-sensitive items. More predictable styles are outsourced to manufacturers in Asia. The throughput time from beginning of the design phase to the arrival of the finished goods in the stores is 4 to 5 weeks for new items and 2 weeks for modifications to existing items.

The sourcing and manufacturing process are also key to the business model. Zara has purchases offices in the fashionable cities of Barcelona and Hong Kong which allow for the purchases to also serve as trend-spotters. Zara uses an Inditex subsidiary, Comditel, for its purchasing of fabric. Approximately half the fabric is purchased in grey to allow for flexibility in manufacturing a variety of colors and patterns. This is a key component of the business cycle as the fabric is finished in just one week. The particular distinction of Zara’s manufacturing is that they manufactured its most fashion-sensitive products internally and produce in small batches for the most time-sensitive ones.

For distribution, all merchandise is shipped through either the central facility in Arteixo, Spain, or through satellite sites located in Argentina, Brazil and Mexico. Merchandise in the main facility has a capacity of only 45,000 folded garments per hour. This facility admittedly has its limitations unless more capacity can be created elsewhere. Also, the vertical integration of manufacturing and distribution greatly helped to reduce the Bullwhip effect.

On the retailing end, the business model allows for Zara to have a much more fashion forward line because it can commit to its product line much later in the season. In fact, the design process does not seem to stop and the designers are constantly evaluating consumer preferences. Zara’s in-store staff is also young, and very fashion-conscious who serve as key “trend-spotters”. In addition, Zara provides very limited volumes of new items in the most fashionable of Zara’s stores and then uses the results of those sales to decide whether the items should also be sold in other locations. The limited volume and short available time successfully created a sense of ‘scarcity’ in consumer’s perception.

Current Issues

Zara is facing several issues. Zara has a consistent business system that gives the company its competitive advantage. One of these advantages is the economies of scale that Zara is able to utilize and the company has been successful in scaling up its distribution system. However, with continued growth, especially due to expansion in the international markets, there is some concern in regards to Zara’s centralized logistics model. The company is concerned with diseconomies of scale as it grows. To address this issue and increase capacity, Zara has begun construction of a second distribution center in Zaragoza.

The other concern facing the company is in the area of international expansion and its geographic scope. The company realizes that it needs to continue to expand internationally. However, which territories to enter is somewhat unclear. The opportunities to expand within Spain are limited based on H&M experience in Sweden. One possibility is to expand in Europe itself, specifically targeting Italy. Another region is North America, but this region suffers from retailing overcapacity, less fashion-forward sense, demand of larger sizes, higher operating costs, intense competition and weakening demand. South America is much smaller and also subject to profitability pressures. Middle East is also a small market though profitable. Lastly, the Asian market is very competitive.

With this continued expansion, the other question facing the company was the model it should utilize in each country. The company had experimented with franchising, joint ventures, and company owned stores. The questions it faced now were which of these to utilize. Also, should it start up chains or acquire existing ones. The real issue was to perform all these activities while maintaining profitability and revenue growth requirements.

Recommendations

Short Term:

Zara faces a myriad of options on how the company wishes to grow. After careful analysis, a few key recommendations emerge. The first of these recommendations is to further expand into Europe. Given Zara’s centralized distribution system which is already located in Europe (Spain), it seems that Zara will have the easiest time leveraging its existing system in regions within relatively close proximity to its main centers. Specifically, Zara should look into aggressively increasing its presence in Italy. Zara has already attempted to enter the Italian market twice through joint-ventures. The latest of these events paid off with the successful opening of a massive store in Milan, the largest Zara store in Europe. Zara can “piggyback” off this success and aggressively establish a presence in the lucrative Italian market. Aside from the Italian market, there are numerous other European markets that Zara can and should further expand into. Among these are Eastern Europe and Germany.

Another important strategic recommendation involves the Asian market. Zara should hold off on this expansion route.. Although huge in scope, the Asian market has proven to be a market of intense competition. Not only does such competition squeeze margins but it requires careful strategy if success is to be achieved. If Zara is focusing on an aggressive expansion program in Europe, it cannot devote the resources and focus necessary to achieve great success in such a competitive market as Asia. Furthermore, although there is intense competition in the Asian clothing industry, established brands can still earn a price premium over the competition in this market. A larger presence in Europe will only raise Zara’s cache and make it easier for the company to compete in the Asian market in future.

Other markets that Zara is considering expanding in are the South American and Middle Eastern markets. It is advisable that Zara not seek growth in these markets, at least initially. The South American markets are much smaller than some of Zara’s other growth opportunities. They are also subject to profitability pressures that are thought likely to continue. The Middle Eastern markets, although more profitable than South America, is even smaller in scope than South America. With other much larger growth opportunities available to Zara, the company should not expend valuable focus and resources in these regions (at least not in the short term). However, the Middle Eastern markets do offer profitable opportunities. Thus, Zara should explore growth in these markets but not before attacking some of the bigger growth markets.

To support this growth, Zara must scale up its distribution system. The case mentions that Zara was beginning construction on a second distribution center which would add substantial capacity to the system. Although some argue that a centralized logistics model might suffer from diseconomies of scale and that what worked well for a 1000 stores will not work well for 2000 stores, the increased capacity that Zara will gain from expanding its distribution centers will be pivotal in supporting the growth of the company.

Long Term:

Zara should look into expansion into the US market. Zara is operationally strong and should be able to out-compete other companies on this dimension. Even though Benetton and H&M had trouble with this area in the US market, Zara’s track record indicates that it should be able to compete. For example, GAP shows revenues 5 times larger than Zara’s, but its COGS is 70% of net revenues vs. only 48% for Inditex. For GAP, operating expenses account for 92% of the gross margin and for Inditex, this number is only 58%.

GAP suffered declines due to its inability to reposition itself to a more fashion-driven assortment and is not profitable due to its high COGS and operating expenses. Zara’s system may help it avoid both of these mishaps. It has room to grow in the US market if it can keep its costs low and continue to monitor trends via its sophisticated IT system, store managers, fashion-conscious staff, and designers (trade magazines, fashion shows, industry research, etc.).

Zara’s competitive advantage is in its business system. However, when Zara moves into international markets, it loses some of these advantages. It loses some control over costs – shipping costs, tariff costs, etc. Zara can overcome this problem by re-configuring its system to a less centralized approach. It should keep some portions of its systems centralized (such as designing, purchasing, etc.) but should move manufacturing and distribution to the international market. For example, in the US market the company can establish a manufacturing facility in Mexico (or US) near its satellite distribution center in Mexico. It can also expand this distribution centers to service the US market. The products can be purchased centrally and then shipped from Comditel directly to North America for manufacturing and distribution, instead of having to go through Spain. This will result in a slight increase in manufacturing cost (due to increased labor and facilities costs in US), but these will be offset by reduced shipping and tariff costs. The rest of the system can stay centralized and provide support for the North American manufacturing and distribution.

By utilizing this method, Zara may be able to reduce its costs. The current prices are based on market conditions and therefore Zara can leave the prices intact and enjoy greater margins, which would help preserve its margins and allow it to invest in systems to sustain its competitive advantage.

The other issues in the US market are retailing overcapacity, less fashion-forwardness, need for larger sizes, and considerable internal variation. Zara’s current system of IT and mangers feedback system to designers will help Zara avoid overcapacity. Manufacturing and distributing close to the source (in US) will help Zara address the latter three issues.

Implementation and Risks

Zara is already in the process of implementing a second distribution facility in Zaragoza. This will help with its continued European expansion. Now that it has a flagship store in Milan, it should continue expanding in Italy. Zara should continue expanding like it traditionally has in the rest of Eastern Europe with its “oil stain” approach. It already has a presence in many of the countries like Germany and Poland. Therefore, its expansion will be more of the same. Its distribution system is already in place, so integration of the new stores into the network will be something Zara already has experience in.

For overseas expansion, it requires much more capital. Zara will need to invest in manufacturing and distribution facilities in North America as it moves into that market. As soon as it has the capital requirements, Zara should build a manufacturing facility in North America. In addition, Zara will have to invest in training the management to be able to operate these facilities in a similar fashion. The purchasing and designing can continue to stay centralized. However, the new facilities will need investments in IT and logistics to communicate with the current systems and utilize the existing knowledge in the system.

The risks involved by expansion into the US market are clear. There is intense competition, higher operating costs, and weakening demand in the US market. This clearly poses a risk to the growth Zara may be able to obtain. This can result in capital losses and similar obstacles were faced by both Benetton and H&M.

Other risks that company faces are to its margins with international expansion. The company is unable to control the increased costs in exporting to foreign countries and currently passes these costs to the consumer. However, it may be difficult to continue doing this and margins are likely to get squeezed. The company needs to be able to grow while maintaining these margins. If it is unable to do so, it risks threats to its competitive advantages and cost efficiency.

Zara also faces risks to its image and therefore has to be very careful in regards to franchising and joint-ventures. With these models, Zara may have a limited role in operating the retail locations. However, if these are poorly managed and operated, there is a possibility of tarnishing the brand and the image that Zara has created. This can also effect the positioning and market segmentation strategy in a particular country – for example, in South America, the company has to position itself as a “made in Europe” brand.