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  1. 1. ZARA: Fashion Follower, Industry Leader Business of Fashion Case Study Competition Amanda Craig, Charlese Jones and Martha Nieto Philadelphia University April 2, 2004
  2. 2. ZARA: Fashion Follower, Industry Leader Table of ContentsIntroduction………………………………………………………………….1Financial Analysis andComparison…………………………………………………….…………....1StrategicAdvantages………………………………………………………………...2-3StrategicDrawbacks…………………………………………………………….….. 3-4Possibilities forFailure…………………………………………………………………....…..4Recommendations/Conclusion………………………………………………5Calculations and FinancialStatements……………………………………….……………….Appendix AArticles: The Recent Status ofZARA.……………………………………….…………………...Appendix BWorks CitedWorks Referenced
  3. 3. The global apparel market is a consumer-driven industry. Also, globalization and newtechnologies have allowed consumers to have more access to fashion. As a result, consumers arechanging, competition is fierce, and companies are evolving to meet these demands. Zara, aSpanish-based chain owned by Inditex, is a retailer who has taken a new approach in the industry.With their unique strategy, Zara has the competitive advantage to be sustainable. In order tomaintain that advantage and growth they must confront certain challenges that face traditionalretailers in the apparel industry.Financial Analysis and Comparison To prove Zara has the prospect of sustainable growth in the international apparel market,it is important to understand and compare the financial differences of Inditex, its parent company,and its major competitor. The most interesting of Zara’s competitors for comparison is Hennesand Mauritz (H&M), who as the case study states, “was considered Inditex’s closest competitor,[with] a number of key differences” (Ghemawat 5). H&M differs from Zara because theyoutsource all of their production, spend more money on advertising, and is price-oriented. Thekey similarities for comparison between Zara and H&M are that they are European basedcompanies, are fashion forward at lower price retailers, and have a strong international expansionstrategy (1; 5). Just looking at Exhibit 6 from the case it is easy to see that their financial status is arecomparable (24). Their net operating revenues are closer to each other than that of Benneton orthe Gap, as is their net income. The best way of comparing Inditex and H&M’s financials is byusing ratios and not merely a visual assessment of the financial statements given. The currentratio1 shows that for every euro in short-term debt, Inditex has 1.02 million euros in currentassets. H&M however, has 3.40 million euros in current assets for every euro in short-term debt.From this we can infer that Inditex is less liquid, possibly because they have more fixed assetsand turn their inventory over quickly. To support this inference, the inventory turnover ratio2 wascalculated that Inditex turns over its inventory 4.42 times per year. This does not mean, however,that H&M is more efficient due to its liquidity. H&M is not making good use of the cash thatthey have because cash not invested does not generate a return. H&M’s excessive inventoriesmay be the main contributor to its high current ratio because they do not own manufacturingfacilities and have to store products in a warehouse. The operating profit margin3 was calculated to measure the efficiency of the companies’profit per euro of sales. Inditex’s operating profit margin is 21.6% and H&M’s is 13.1%. Inditexis more efficient in generating a greater profit per euro of sales than H&M. Inditex’s higheroperating income4 is a result of keeping their costs of goods sold and operating expenses muchlower than H&M’s. Inditex’s decreased costs are made possible by in-house production, loweradvertising expenses and keeping a cost-effective number of employees per store. H&M only has771 stores to Inditex’s 1,284, but has a higher number of employees per store5, 29.7 to Inditex’s20.8. H&M’s high employee to store ratio is partially to blame for their high cost of goods sold. There is a disparity between the working capital6 of Inditex and H&M, which is themoney available to meet current obligations. Inditex only has 20 million euros of working capitalas compared to H&Ms 1035 million euros. This is because Inditex invests more than H&M infixed assets7, Inditex owns 1228 million euros in property, plant, and equipment and H&M onlyowns 661 million euros. Having a small amount of working capital could potentially hurt Inditexbecause it could affect their ability to meet any liability obligations that may arise. Inditex is efficient in its operating economics, as compared to H&M, due to thefact that they have higher margins. Their operating profit margin is approximately 1.5times higher than that of H&M. Their relative capital efficiency is lower due to the factthat their working capital and their profits per store are much less than H&M’s. Inditex’soperating profits per store8 is 54.8% as compared to 76.4% of H&M. This is becauseInditex is building more stores based on projections and anticipated future value. As long
  4. 4. as Inditex’s profit margins are high, they will be able to have sustainable growth becausethey will have the money to invest and pay expenses.Strategic Advantages Zara has been able to achieve excellent financial status due to its core competencies thatprovide the chain with a competitive advantage over traditional retailers in the industry. Zara is anapparel chain that works differently from traditional retailers. Generally, a traditional retailer suchas Express owned by Limited Brands (a top U.S. specialty retailer group), outsources all of itsproduction while focusing on distributing and retailing those goods. This is due to the fact that theglobal apparel industry is “highly-labor intensive” rather than capital intensive (2). Fashionretailers and apparel manufactures are always seeking to lower costs by outsourcing production todeveloping countries where the lowest labor rates are found. In contrast, Zara is a chain that hasdeveloped a successful diverse method of doing business in the fashion industry. Zara by workingthrough the whole value chain is very vertically integrated and highly capital intensive. Vertical integration, a distinctive feature of Zara’s business model, has allowed thecompany to successfully develop a strong merchandising strategy (Herreros). This strategy hasled Zara to create a climate of scarcity and opportunity as well as a fast-fashion system. Zaramanufactures 60% of its own products. By owning its in-house production, Zara is able to beflexible in the variety, amount, and frequency of the new styles they produce. Also, 85% of thisproduction is done through the season, which allows the chain to constantly provide its costumerwith very updated products (Ghemawat 9). Traditional retailers lack this flexibility. Traditionalretailers are obligated to place production orders to manufacturers overseas at least 6 months inadvance of the season. Zara’s in-house production purposely creates a rapid product turnover since its “runs arelimited and inventories are strictly controlled” (12). This rapid product turnover creates a climateof scarcity and opportunity in Zara’s retail stores. The climate also increases the frequency andrapidity with which consumers visit the stores and buy the products. Regular customers know thatnew products are introduced every two weeks and most likely would not be available tomorrow.Therefore, Zara’s scarcity climate allows the company to sell more items at full price. Thisstrategy minimizes Zara’s total cost because it reduces 15-20% of markdown merchandisecompare to a traditional retailer. Furthermore, Zara’s unique quick response system, composed of human resources as wellas information technology, allows Zara to respond to the demand of its consumer better than thecompetition. Zara, who focuses on the ultimate consumer, places “more emphasis on usingbackward vertical integration to be a very quick fashion follower than to achieve manufacturingefficiencies” (12). It is extremely important for Zara to speed the information flow of consumerdesires to their apparel designers. For that reason, Zara has human resource teams in the retailand manufacturing environment that work exclusively toward this goal. In the manufacturing environment, Zara’s product development teams are responsible forattending high-fashion fairs and exhibitions to translate the latest trends of the season into theirdesigns. Also throughout the season, Zara’s product development teams are constantlyresearching the market by traveling to universities, and clubs around the world to track customerpreferences. Additionally, the young, fashionable, and international staff helps to interpret thedesire of the moment (Zara). In the retail environment, Zara’s managers and sales associates are in charge oftransmitting the sales analysis, the product life cycles, and the store trends to the designers. Thisallows the designers in Spain to develop the right products within the season to meet consumerdemand (Ghemawat 10). The transfer of this communication is also accelerated by IT softwarethat is specifically designed for Zara’s diverse business (Zara). Zara’s quick response communication strategy is effective due to its management andcorporate culture. Amancio Ortega, the founder of Inditex, still owns 60% of Zara’s shares. Mr.Ortega has effectively transmitted the values of the company, which are: freedom, perfectionism,
  5. 5. responsibility, rapidness, flexibility and respect to others, to his management team (Zara). Thishas created a very autonomous and flexible corporate culture for Zara. Also, this has allowed thecompany to work horizontally with an open communication environment rather than a hierarchalone. Due to this, Zara’s managers work in teams in the countries where the chain is located.These divisional headquarter teams are composed of a head country manager who is constantlycommunicating with local managers and reporting to top management (Ghemawat 18). Theconstant flow of information between managers allows the company to keep its customers happy,which results in increased sales. Moreover, Zara’s centralized distribution facility gives the chain a competitive advantageby minimizing the lead-time of their goods. Zara’s internally or externally produced merchandisegoes to the distribution center. This is cost-effective due to the close proximities of thedistribution center in Arteixo and their factories in Coruña. In the distribution center, products areinspected and immediately shipped, since Zara’s distribution center is a place where merchandiseis moved rather than stored (12). Then, to increase delivery speed, the shipments are scheduled bytime zones and shipped by way of air, and land. The typical delivery time within and outsideEurope is between 24 to 48 hours (11). Zara also has an advantage over its competitors due to its low advertising costs. Zara’sadvertising investment is 0-.3% as compared to traditional retailers who expends 3 – 4% (13).Zara’s cuts in advertising investments reduce total expenses, which make the internationalexpansion more economical (16). This also signifies that Zara relies mainly on its stores to projecttheir image. For that reason, Zara has a department, which exclusively works in acquiring globalprime real estate locations. In addition, this department is responsible for the frequentrefurbishing of store layouts, as well as the creation of a common window display for Zara’sglobal stores. The display positions Zara in the industry with a prestigious and elegant image(Zara). By targeting a broad market Zara has an international advantage over its competitors.Zara’s target market is very broad because they do not define their target by segmenting ages andlifestyles as traditional retailers do. Zara’s target market is a young, educated one that likesfashion and is sensitive to fashion. Today, people around the world through variouscommunication devices have more access to information about fashion. Therefore, fashion hasbecome more globally standardized and Zara uses this to their advantage by offering the latest inapparel. For that reason, 80- 85% of the products that Zara offers globally are relativestandardized fashionable products. This is due to the fact that Zara’s marketing teams believe thata product that sells well in a fashion capital such as New York will most likely sell well inanother such as Milan, Sao Paulo or Madrid since fashion has become more globally accessible(Zara).Strategic Drawbacks Although Zara has a successful business model that differs from that of traditionalretailers, it also has disadvantages that can affect its sustainable growth. Due its model, Zara’sweaknesses also differ from the traditional retailer. Zara holds around 86% of Inditex’s totalinternational sales-a significantly high number for an organization that has 7 other chains(Ghemawat 15). With that, Inditex is putting all of their eggs into one basket by sinking a greatdeal of capital into Zara. Inditex has contributed their extensive international sales to Zara andsaid “Zara was the principal reason Inditex’s sales were increasingly international” (15). If Zarafails in the future, Inditex will have to totally re-formulate their firm’s strategies and may possiblyface an internal meltdown. Zara also has an inability to penetrate the American apparel market. This may be due toAmerican tastes that differ from European preferences. More importantly, however, Zara has notbeen able to develop a strong supply chain strategy in the U.S. like they have in Europe. TheirEuropean strategy includes, having a strong production and distribution facility in their homecountry in order to have short production and lead times. Zara has not invested in distribution
  6. 6. facilities in the Americas, which is a threat to their U.S. selling abilities since the U.S. makes up29% of the total apparel market (19; 4). This may make them “subject to diseconomies of scale”,which means that though are aware of how to quickly supply 1,000 stores, they may not be ableto supply more retail locations due to their “centralized logistics model” (12). Zara’s strategy also creates some weaknesses. Their vertical integration has moreadvantages than drawbacks but it is important to recognize its limitations. Verticalintegration often leads to the inability to acquire economies of scale, which means theycannot 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 supporttheir own high capital investments for their chains and be able to financially back their“technology and skills beyond those currently available within the organization” (David145). Zara’s speedy and recurrent introduction of new products incurs increased costs aswell. They have higher research and development costs. They also have elevated costsdue to the constant changeover of production techniques to create their different apparellines. That also means that employees must be trained in order to use the newmanufacturing techniques, which again leads to increased costs. Traditional retailers donot experience higher costs in all of these areas.Possibilities for Failure Like traditional retailers, Zara has a threat of failure that can harm its sustainable growth.The European switchover to the common currency called the euro has created the potential threatfor the Spanish Zara chain. In July 2002 the euro was the only currency accepted for alltransactions in member countries of the European Union (“Euro”). If the euro becomes strongeragainst the American dollar, than production costs will increase for European producers. Theeuro switchover will increase Zara’s cost of production. That cost increase will be carried over tothe consumer with higher prices. This threat of the euro may also create a threat of decreasedsales because apparel prices will be too high for the traditional Zara shopper. Another threat lieswith the quota elimination under the World Trade Organization agreement on textiles andclothing expiring in 2005. Traditional retailers who outsource goods can benefit from greateraccess to less expensive manufacturing. Zara will suffer from a high euro and the threat of itscompetition offering more inexpensive products. Zara’s direct competition may be their largest threat, especially when expanding into newgeographic territory. Almost any retailer can be a threat to Zara due to their wide range ofmerchandise categories. Zara offers clothing and accessories for men, women, maternity,children, and baby. Many other retailers also offer goods to one or all of those merchandisegroupings. The Gap is one of these competitors because they are also international and sell thesame range of merchandise with a less trendy style. H&M (Hennes and Mauritz) is probablyZara’s most similar and threatening competitor. They too have been quick to “internationalize”,which allows them to gain sales in countries outside their native Sweden (Ghemawat 5). H&Malso is more attentive when entering new markets and tends to enter one country at a time, asopposed to Zara who multitasks globally (5). H&M builds distribution centers in theirinternational locations in order to cut down lead times and potential logistical costs. Anotherthreat to Zara is that H&M carries trendy clothing choices that they have designed based on themelding of international apparel tastes. However, H&M offers these styles at a cheaper rate thanZara (5). H&M also uses more advertising than Zara, but not as much as the Gap, which may aidthem in entering new markets successfully because the local customer is aware of H&M’smerchandise mix. A final threat to Zara is the issue of cannibalization. Zara’s extensive location strategyinvolves putting multiple Zara stores that carry the same merchandise in the same cities. Thatmeans Zara is trying to sell the same exact merchandise to the same people that reside in that city.For example, the two hundred and twenty-five Zara stores in Spain can cannibalize sales from
  7. 7. each other especially if multiple locations are within the same city. Also, the other 544 Inditexstores located in Spain can cannibalize Zara’s sales since the majority of the chains have a similartarget market to Zara. This is similar to the challenges faced by the Gap versus Old Navy: Gap’ssales were cannibalized by Old Navy’s lower prices (Lee).Recommendations The best way for Zara to maintain their sustainable growth is to seek new opportunities inthe apparel market. With changing consumer behaviors as a result of globalization, and U.S.department stores suffering, there are growth options available for specialty retailers like Zara.Zara has the opportunity to be one of the trendiest/low priced retailers that America has seenrecently. Zara should most likely develop a second central distribution center in the Americas todecrease logistics in order to deliver fashionable goods in a faster manner. Their second centraldistribution facility should be an expansion of one of their smaller distribution centers located inArgentina, Brazil or Mexico. The close proximity of the distribution center to the Americanmarket will allow them to effectively interpret the particular American fashion. The distributioncenter will also allow them to have additional funds to spend in other areas of business such asadvertisements: a necessary feature to penetrate the American market. Another market opportunity for Zara is to invest in Internet retailing especially directedtoward the U.S. market. Though Zara is wary of overexposure, Americans like to be able topurchase all goods including apparel from the comfort of their own homes at any time they chose.Therefore, since Zara is looking to expand in the U.S. market they could realize the potential for adirect Internet selling strategy. That form of direct marketing will reach more consumers fasterand easier. Though it may be difficult to display all of Zara’s ever-changing fashions online, itmay prove profitable for shoppers to purchase a moderate selection of trendy Zara pieces alongwith some of their staple basics. A final recommendation for Zara is to offer specialized products for different geographiclocations within the same city. Zara already does this to an extent for different internationalpreferences but more specialization will increase consumer demand and will motivate them tovisit more Zara locations within their own region. In some cities the company is possiblyexperiencing cannibalization because there are too many Zara stores that carry the same productwithin one city. Zara could differentiate its product from location to location to increase shoppertraffic. This would work because shoppers would hear about new/different products (possiblyfrom word of mouth or increased advertising) that another Zara store is carrying across the cityand they would be intrigued to pay a visit. That way sales wouldn’t be stolen from their ownZara stores, decreasing cannibalization for the chain. In conclusion, Zara has the potential for sustainable growth due to its competitiveadvantage and its ability to face the challenges of the apparel industry. The company keeps itsoperating income elevated, has a strong and unique business model, and has various opportunitiesfor expansion in the retail industry. To many Europeans, Zara is a familiar face with consistentlytrendy, well-priced new apparel every week. To Americans, it is a company that is just getting itsfeet wet in the American market. Though, the Inditex branch is researching and developing newmethods for expansion, the company must continue to re-invent and innovate themselves in orderto stay fresh in the apparel industry. Today, many companies are looking to Zara as the newindustry standard for how to run a retail business, which shows that Zara’s business model isbecoming the wave of the future.1 See Appendix A2 See Appendix A3 See Appendix A4 See Appendix A5 See Appendix A6 See Appendix A7 See Appendix A8 See Appendix A