1. With which of the international competitors listed in the case is it most interesting to compare Inditex’s financial results? Why? What do comparisons indicate about Inditex’s relative operating economics? Its relative capital efficiency? We think H&M’s financial results are the most interesting one to compare with Inditex’s. H&M is the most important and largest competitor of Inditex and due to their similar background, both being large international European apparel brands and offers fashionable clothing with in season style.
We have notice and quoted from Exhibit 6, their net operating revenues, aka their sales, are more alike when compared to Gap and Benetton; and their net incomes are also similar. The negative ROE in Gap, caused by the failed attempt of repositioning and the massive decline in stock price during 2001, affects the total financial figure of Gap too much that we think it not suitable to be used to directly compare with Inditex’s results. As for Benetton, we find its sales, net income and operating profit per store especially low to be compared with the other 3 firms.
Inditex has an operating margin of 21. 7% while H&M has a 13. 1%. The operating margin can be used as a measure of each firm’s capital efficiency. It shows that Inditex has a greater power to earn a profit per each Euro of sales than H&M. Inditex, though has lower net operating revenues, but has resulted in keeping their operating income higher than H&M. This may be done by lowering cost of goods sold and having a smaller proportion of staff employed. Inditex owned 1,284 stores, hiring 26,724 people while H&M owned 771 stores, hiring 22,944 people. Inditex has a lower staff to store ratio than H&M.
This keeps the amount of money needed to be paid as wages low. Inditex also spends lower advertising expense than H&M, only 0. 3% of its revenue and by using vertical integration, i. e. production by own self, lower the total costs. There is a huge difference between the working capital of Inditex and H&M. Inditex has around 20 million working cap. While H&M has around 1036 million. Working capital is a measure to show the ability of paying off debts or act as a cushion to a sudden need in money. The low working capital of Inditex may be a cause of the larger amount of PPE Inditex owned.
Inditex owned 1,228 Million Euros of PPE while H&M owned only around half the amount Inditex has, 661 million Euros. This may be a potential danger to Inditex if any sudden liability occurs, Inditex might not be able to pay the debt off. With respect to operating economics, Inditex is having a relatively higher or more efficient one than H&M. This is mainly due to the high operating margin Inditex has over H&M. Inditex’s operating margin is 66% more than H&M, but when comparing their relative capital efficiency, we consider H&M as the more efficient one. H&M has a much higher operating profit per store than Inditex does.
Profit per shop in H&M is 0. 764 million Euro while Inditex has only 0. 548 million. This difference in profit is contributed by the large number of stores Inditex has opened and operated and therefore resulted in lower relative capital efficiency. Inditex will have to maintain a high operating margin in order to cover the expense or liability and use the money for further investments. 2. How specifically do the distinctive features of Zara’s business model affect its operating economics? Specifically, compare Zara with an average retailer with similar posted prices.
In order to express all advantages/disadvantages on a common basis, you may find it convenient to assume that on average, retail selling prices are about twice as high as manufacturers’ selling prices. | |Representative Competitor |Zara | |Posted Selling Price |100. 0 |100. 0 | |-Markdown |-10. 5 |-2. | |Retail Selling Price (RSP) |89. 5 |97. 4 | |-Manufacturing Costs/Selling Price |-44. 75 |-48. 7 | |Gross Margin |44. 75 |48. 7 | |-Advertising |-3. 5 |-0. 3 | |Advertising-Adjusted Margins |41. 25 |48. | | | | | Fig. 1 Comparative Operative Margin Analysis Remarks of the table: Markdown = Markdown price x percentage of goods that needed to be marked down – Representative Competitor: 0. 3 x (0. 3+0. 4)/2 = 0. 105 = 10. 5% Zara: 0. 15 x (0. 15+0. 20)/2 = 0. 02625 = 2. 6% Manufacturing Costs/ Selling Price are assumed to be half of the RSP As seen from the table, we can see that the largest differences between Zara and other competitors are the lower markdown percentage and the lower advertising expenses.
The lower markdown percentage is mainly because of Zara’s strategy on risky items due to design mistakes, which may lead to large number of inventory. If any Zara’s product was slow to sell in one place, it will be immediately apparent and weeded out by the store managers. Then these goods were sent back to the distribution center and either ship to and sell at other Zara stores or dispose of through a separate chain of stores near to the distribution center. These help minimize the inventories that needed to be sold at marked-down price at the end of the season during the sales period.
As a result, the overall markdown percentage of Zara was much smaller than other competitors. Other than the markdown percentage, less advertising also gives Zara a big advantage over the others. Zara usually limits the advertising to only at the start of the sales period at the end of the season. All new items and new designs were first displayed and arrived in its major stores in each twice-weekly shipment. So the customers of Zara always know when will the new designs come. As a result, Zara doesn’t need to advertise its newest designs and thus its cost spent on advertisements was much lower than the other competitors.
In conclude, due to its distinctive features of business model, Zara would have advantage on markdown and advertising cost which makes Zara’s profit margin is higher than that of other competitors. Moreover, we have assumed that the manufacturing cost of Zara is half of its RSP and thus is higher than other average competitors. However, Zara sources most of the materials and 60% of its finished garments from all over the world. Especially for the basic items, they were outsourced to Asia’s contracted suppliers which were cheaper than European suppliers.
As a result, Zara’s production cost shouldn’t be that high. It should be similar to the competitors or even lower than theirs. If this were the case, the difference between the profit margins of Zara and other competitors would be even larger. 3. Please list out ways/activities which ZARA creates its competitive advantage in the following areas: • Design • Sourcing and manufacturing • Distribution • Merchandizing • Store operations • Management Zara creates its competitive advantage from activities in six areas, design, ourcing and manufacturing, distribution, merchandizing, store operations, and management. Firstly, Zara has a creative team with designers, sourcing specialists, and product development personnel, producing various product items in short cycle time, four to five weeks for new design and only two weeks for modification. Then, the team continuously tracked customer preference via different means, for instance frequent conversations with store managers obtaining sales data which reflects customers’ preference, searching information from industry publications, Internet etc.
It also shows that there was good information circulation within the organization. Even though many items were designed each day, only about one-third of them went into production in limited volumes and presented in certain key stores. A larger scale of new items would be produced if they got good customer reaction. Minimizing the cost wasted on producing too many items with negative consumer reaction. Next, in sourcing and manufacturing, since the business model of Zara was vertical integration, its in-house production with just-in-time system created the competitive advantage.
There were about 40% of garments were manufactured internally since Zara fully owned 20 factories and most of them located near by its headquarters in Arteixo. It controlled the cost of production and the product item produced. On the other hand, it had a systematic mechanism regarding the sourcing, for those items that were more price-than time-sensitive were outsourced to Asia, otherwise, the items were sourced from Europe and North Africa. Then, Zara’s centralized distribution system minimized the lead-time of their goods. All produced garments were sent to the distribution center in Arteixo where was close to the factories.
In the distribution center, products were packed and shipped away directly, since, according to Lorena Alba, the warehouse is “a place to move merchandise rather than to store it”. Besides, Zara scheduled shipments by time zone and shipped by the way of land or air. It increased the speed of delivery and the delivery time within and outside Europe was between 24-36 hours. Furthermore, Zara has rapid product turnover that gives consumer the feeling of freshness of garments and it creates a climate of scarcity and opportunity since new products are introduced every two weeks and may not be available in one or two days.
For those garments that were slow to sell, store managers would return them to the distribution center, then, those goods were either shipped to and sold at other Zara store or disposed of through a small, separate chain of closeout stores near the center to minimize the inventories. Regarding the store operations, Zara uses its stores to promote their market image, that are the centralization of store window displays and interior presentations like uniforms of employees wear and it can help lowering their advertising cost.
Moreover, the turnover rate of store manager is low since 90% of store managers are promoted from within, and they have power to make decision for merchandise to order, to discontinue. And for the management activity, there are country general managers act as bridges between headquarter and local store mangers by means of regular meetings communicating with local managers and reporting to top management so that there are constant information flow between managers that allow the company to function better.
In addition, the ability of country managers to control local store operations was enhanced by using the standardized reporting system, and thus, the performance of store operations became more efficient, increased the sales. 4. Why might Zara “fail”? How sustainable would you calibrate its competitive advantage as being relative to the kinds of advantages typically pursued by other apparel retailers? Vertical integration The vertical integration strategy adopted in Zara has its limitations and drawbacks that should not be omitted. Admittedly, vertical integration adopted by Zara allowed it to develop a strong merchandising mode of usiness and to create consumers’ perception of scarcity and a fast pace fashion system. Yet, vertical integration does have its inborn weaknesses. For instance, this strategy could lead to the inability to attain economies of scale, which means when large quantities of goods are produced, the costs rate will not be discounted. Thereby, mass production will result in incurring high costs for Inditex Corporation. In addition, developing vertically integrated logistic system in different countries with high labor cost will need high production cost.
Zara has been considering the investment in distribution and production in the new regions that they are expanding into such as North America and Asia which seemed to be the obvious regional opportunities. As for the U. S. market, Zara is already in major cities of the United States. Zara does not have any distribution or manufacturing facility within United States so all the apparel has to be shipped from Europe to the United States which results in a significantly high transportation cost. High R&D costs Current Zara’s business requires high research and development costs.
The reasons behind is attributed to the fast pace products designs and introduction. There is also a constant innovation of production techniques in creating various product lines. In this sense, costs for training and development of staff are also one of the main burdens for Inditex as employees have to be trained for manipulation of new manufacturing techniques. Yet, other traditional retailers do not have experienced such high costs in these respects. As for Inditex, it has to financially support the technology and skills required which costs much of their capital investment.
For tracking latest fashion trend, Zara has adopted several means that requires much on human resources. First of all, Zara has a designated product development teams which are responsible for regularly attending fashion fairs and exhibitions to translate the latest trends of the season into their designs. Besides, Zara’s product development teams are constantly researching the market by visiting universities and clubs around the globe. What’s more, the young, fashionable, and international staff are also involved in interpreting the latest fashion sense.
Centralized distribution system Zara’s internally or externally produced merchandise goes to a single distribution center. Like traditional retailers, it might be failed and the company’s harm sustainable growth. The current centralized logistic strategy has created the problem of diseconomies of scale for Zara. Although it has pay much attention on how to supply its 1,000 stores in a faster pace, it may not be capable of supplying more retail locations because of the centralization in logistic.
Although Zara had successfully scaled up its distribution system, the logistic system might be unavoidably subjected to diseconomies of scale when it continues to start up stores all over the globe yet ship the products from its only Distribution Center in Europe. Such a centralized system will only be working well with the current amount of Zara’s stores which are mainly located in European cities. Nonetheless, as they are branching outside Europe, say to some Asian cities, inefficient logistic and high operational cost will probably be the result if Zara remains to own a single Distribution Center. Keen Competition
Zara might face keen competition in offering inexpensive products which is a thriving strategy nowadays. Apart from pricing, Zara’s target market is very broad because they do not have clear definite target markets. They do not segment their target markets by ages and lifestyles as traditional retailers do. Therefore, Zara’s direct competition may be their largest threat, especially when expanding into new countries. Any retailer can be Zara’s competitors and post a threat to Zara due to their wide range of merchandise categories. Zara’s product lines include clothing and accessories for men, women, maternity, children, and baby.
Some of the lines, if not all, are also offered in many other retails. The Gap is precisely one of those who sell the same range of merchandise as Zara over the world yet with a less trendy style. H&M is regarded as the direct and strong competitor of Zara due to the similarity in products’ fashion styles. The products that available in H&M are designed based on the apparel tastes and trends in an international term. The most obvious threat to Zara is that H&M offers fashionable products with cheaper prices that are attractive to a large group of consumers who value fashion as well as price.
Another example of competitors comes to Threat of strategy standardization Zara may have a threat of cannibalization . Zara is keen on expanding over the world while keeping its standardized production line and strategy. This is dangerous as every country has its unique and characterized features in economic, cultural, social and political conditions. If Zara products are kept standardized rather adjusting to fit different needs on fashion of other countries, it would be fail to enter the market there. How to calibrate:
Under the circumstance that Zara might “fail”, it is necessary to calibrating its core competitive advantages. Zara’s competitive advantages are mainly efficient distribution system, high turnover of its products, low level of inventory, and commitment of its employees as well as meeting the consumers’ fashion demands. Zara may make its core competency, the fast design-product-retail cycle, more global. So far Zara’s rapid expansion gave it a much broader footprint than larger apparel chains, and so we can see that Zara’s advantage succeeded in traveling globally by now.
As the expansion will continue, those competitive advantages of Zara must be adopted in other countries’ practical situation if Zara wants to be more successful in the worldwide competition. In order to have sustainable growth, Zara’s vast expansion strategies and standardized product lines like certain unsuccessful product lines in the Middle East due to cultural norms should be customized on a country or region basis, so it can effectively respond to the local demand without incurring additional costs. With this practice, product lines would perform better and become more feasible in different regions where it would meet heavy demand.
Zara may offer specialized products for different geographic locations within the same city. Although Zara has already attained a certain degree of specialization to an extent for different international preferences, higher level of specialization will increase consumer demand and thus motivate them to visit more Zara shops in different locations within their own region. Zara could differentiate its product from location to location in order to increase shopper traffic. As a result, cannibalization of the Zara chain might be able to decrease. In accordance with Zara’s “fast fashion” strategy, Zara may consider Internet Retailing.
Zara can easily add the e-commerce feature to its website with its existing website. Although trends and styles are always common across all countries due to globalization, some variations in preference and taste can still be found from country to country. Customers can be reached much faster and easier in the countries that Zara is trying to expand into. This method can also help gauge consumer preferences in different countries or regions. Though Zara is wary of overexposure, some customers would still like to purchase apparel on the Internet, enjoying the convenience and comfort of buying at home at any time.
Therefore, Zara should realize the potential and opportunity of direct Internet selling. Zara outsources fabric, other inputs, and finished products from external suppliers. As Zara can purchase from both Europe and Asia according to prices, this gives Zara a competitive advantage towards the costs of goods sold. Buying more from China in the future might reduce even more the costs of goods sold. 5. What other strategic recommendations would you make to Inditex CEO Jose Maria Castellano?
Zara has been expanding fast while maintaining a highly centralized vertically integrated supply chain. Operations and distribution are becoming complex and are approaching a state of diseconomy of scale. Jose Maria Castellano should consider the following options to increase future scalability of the Zara system. First, in short term, overseas shipping costs and arrangements should be renegotiated to reduce the transportation cost as there will not be production plants in overseas in short period of time and the shipping action will remain unchanged for years.
By signing contracts for the coming years, for example, could provide bargaining power to reduce the shipping costs of products which are transported to the Asian markets such as Japan. Keeping the shipping cost low can also help prepare for further Asian market penetrations. This could do help for both short term and long term. Furthermore, in terms of market penetration, our team thinks that it is better for Inditex to penetrate into all European countries, one at a time, before expanding into Asian markets such as India. The American markets are not suitable as there is intense competition.
American retailers can sell products at much lower costs then Inditex due to low transportation cost which is high to Inditex. High selling price of apparel by Inditex in America may not be attractive to American consumers. Moreover, Asian markets, such as India and China, are very large markets thus it would require abundant resources and in-depth research must be done before enter. On the other hand, Inditex is familiar with and has experience in European markets and Europeans have similar tastes and styles. Entering these markets is far easier.
Thus, if Inditex is going to expand into another market soon, we suggest that it should be European countries such as Italy, which with citizens who are fond of fashion. Zara should exhaust all expansion opportunities within Europe before attempting to enter a new foreign region. In the long term, Inditex should decentralize its production to places all over the world to gain advantage of low production cost in different regions. For labour-intensive production process, Inditex may decentralize it to Vietnam or India which has low-cost labour.
Decentralization of production can decrease the complexity of production processes and decrease production time. After long-time research and planning and learning from the business model from Spain, an Asian Headquarter and production center should be set up in India. India can provide low-cost labour and also professionals which are critical for production and maintaining smooth processes. With the Headquarter and production center, Asian markets, e. g. China and India, could be entered with the help of teams of researchers.
As Asians and Westerners have different tastes and fashion, Inditex must form research teams to observe and investigate which type of apparel products are attractive to Asians and concentrate on producing them. Inditex must not concentrate on selling western-style products in Asian market as this may lead to mismatch of tastes and lead to failure of market penetration. With the help of distribution centers, penetration of Asian market will be easier. Two distribution centres should be set up just next to the Headquarter and the production center.
One manages the distribution of apparel to China, Japan and Russia. The other one manages the distribution to Australia and India. With the new production and transporting facilities, cost of production can be largely reduced and selling price of apparel can thus be lowered to match with the Asian market price levels. One or two more distribution centers should also be set up in Spain, just next to the production plant to prevent bigger potential problems as a bottleneck has been slowing built up in the original production and distribution plant in Spain.
Jose Maria Castellano should also stop expanding Indetex’s economies of scope. Inditex now already has six production lines and should be focusing in expanding the production and market share of the current lines. No additional lines should be set up or acquired as new production lines require a lot of research and development. As ZARA is a most-developed and successful line, Jose Maria Castellano should learn from the mistakes and production processes done by ZARA and apply them to the other five lines to assist their development.