ZARA: Fashion Follower, Industry Leader

Business of Fashion Case Study Competition Amanda Craig, Charlese Jones and Martha Nieto Philadelphia University April 2, 2004

ZARA: Fashion Follower, Industry Leader Table of Contents Introduction.1 Financial Analysis and Comparison.....1 Strategic Advantages...2-3 Strategic Drawbacks... 3-4 Possibilities for Failure......4 Recommendations/Conclusion5 Calculations and Financial Statements..Appendix A Articles: The Recent Status of ZARA.....Appendix B Works Cited Works Referenced

The global apparel market is a consumer-driven industry. Also, globalization and new technologies have allowed consumers to have more access to fashion. As a result, consumers are changing, competition is fierce, and companies are evolving to meet these demands. Zara, a Spanish-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 to maintain that advantage and growth they must confront certain challenges that face traditional retailers 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 Zaras competitors for comparison is Hennes and Mauritz (H&M), who as the case study states, was considered Inditexs closest competitor, [with] a number of key differences (Ghemawat 5). H&M differs from Zara because they outsource all of their production, spend more money on advertising, and is price-oriented. The key similarities for comparison between Zara and H&M are that they are European based companies, are fashion forward at lower price retailers, and have a strong international expansion strategy (1; 5). Just looking at Exhibit 6 from the case it is easy to see that their financial status is are comparable (24). Their net operating revenues are closer to each other than that of Benneton or the Gap, as is their net income. The best way of comparing Inditex and H&Ms financials is by using ratios and not merely a visual assessment of the financial statements given. The current ratio1 shows that for every euro in short-term debt, Inditex has 1.02 million euros in current assets. 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 assets and turn their inventory over quickly. To support this inference, the inventory turnover ratio2 was calculated 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 that they have because cash not invested does not generate a return. H&Ms excessive inventories may be the main contributor to its high current ratio because they do not own manufacturing facilities 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. Inditexs operating profit margin is 21.6% and H&Ms is 13.1%. Inditex is more efficient in generating a greater profit per euro of sales than H&M. Inditexs higher operating income4 is a result of keeping their costs of goods sold and operating expenses much lower than H&Ms. Inditexs decreased costs are made possible by in-house production, lower advertising expenses and keeping a cost-effective number of employees per store. H&M only has 771 stores to Inditexs 1,284, but has a higher number of employees per store5, 29.7 to Inditexs 20.8. H&Ms 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 the money available to meet current obligations. Inditex only has 20 million euros of working capital as compared to H&M's 1035 million euros. This is because Inditex invests more than H&M in fixed assets7, Inditex owns 1228 million euros in property, plant, and equipment and H&M only owns 661 million euros. Having a small amount of working capital could potentially hurt Inditex because 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 the fact that they have higher margins. Their operating profit margin is approximately 1.5 times higher than that of H&M. Their relative capital efficiency is lower due to the fact that their working capital and their profits per store are much less than H&Ms. Inditexs operating profits per store8 is 54.8% as compared to 76.4% of H&M. This is because Inditex is building more stores based on projections and anticipated future value. As long

as Inditexs profit margins are high, they will be able to have sustainable growth because they 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 that provide the chain with a competitive advantage over traditional retailers in the industry. Zara is an apparel chain that works differently from traditional retailers. Generally, a traditional retailer such as Express owned by Limited Brands (a top U.S. specialty retailer group), outsources all of its production while focusing on distributing and retailing those goods. This is due to the fact that the global apparel industry is highly-labor intensive rather than capital intensive (2). Fashion retailers and apparel manufactures are always seeking to lower costs by outsourcing production to developing countries where the lowest labor rates are found. In contrast, Zara is a chain that has developed a successful diverse method of doing business in the fashion industry. Zara by working through the whole value chain is very vertically integrated and highly capital intensive. Vertical integration, a distinctive feature of Zaras business model, has allowed the company to successfully develop a strong merchandising strategy (Herreros). This strategy has led Zara to create a climate of scarcity and opportunity as well as a fast-fashion system. Zara manufactures 60% of its own products. By owning its in-house production, Zara is able to be flexible in the variety, amount, and frequency of the new styles they produce. Also, 85% of this production is done through the season, which allows the chain to constantly provide its costumer with very updated products (Ghemawat 9). Traditional retailers lack this flexibility. Traditional retailers are obligated to place production orders to manufacturers overseas at least 6 months in advance of the season. Zaras in-house production purposely creates a rapid product turnover since its runs are limited and inventories are strictly controlled (12). This rapid product turnover creates a climate of scarcity and opportunity in Zaras retail stores. The climate also increases the frequency and rapidity with which consumers visit the stores and buy the products. Regular customers know that new products are introduced every two weeks and most likely would not be available tomorrow. Therefore, Zaras scarcity climate allows the company to sell more items at full price. This strategy minimizes Zaras total cost because it reduces 15-20% of markdown merchandise compare to a traditional retailer. Furthermore, Zaras unique quick response system, composed of human resources as well as information technology, allows Zara to respond to the demand of its consumer better than the competition. Zara, who focuses on the ultimate consumer, places more emphasis on using backward vertical integration to be a very quick fashion follower than to achieve manufacturing efficiencies (12). It is extremely important for Zara to speed the information flow of consumer desires to their apparel designers. For that reason, Zara has human resource teams in the retail and manufacturing environment that work exclusively toward this goal. In the manufacturing environment, Zaras 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, Zaras 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). In the retail environment, Zaras managers and sales associates are in charge of transmitting the sales analysis, the product life cycles, and the store trends to the designers. This allows the designers in Spain to develop the right products within the season to meet consumer demand (Ghemawat 10). The transfer of this communication is also accelerated by IT software that is specifically designed for Zaras diverse business (Zara). Zaras quick response communication strategy is effective due to its management and corporate culture. Amancio Ortega, the founder of Inditex, still owns 60% of Zaras shares. Mr. Ortega has effectively transmitted the values of the company, which are: freedom, perfectionism,

responsibility, rapidness, flexibility and respect to others, to his management team (Zara). This has created a very autonomous and flexible corporate culture for Zara. Also, this has allowed the company to work horizontally with an open communication environment rather than a hierarchal one. Due to this, Zaras 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 constantly communicating with local managers and reporting to top management (Ghemawat 18). The constant flow of information between managers allows the company to keep its customers happy, which results in increased sales. Moreover, Zaras centralized distribution facility gives the chain a competitive advantage by minimizing the lead-time of their goods. Zaras internally or externally produced merchandise goes to the distribution center. This is cost-effective due to the close proximities of the distribution center in Arteixo and their factories in Corua. In the distribution center, products are inspected and immediately shipped, since Zaras distribution center is a place where merchandise is moved rather than stored (12). Then, to increase delivery speed, the shipments are scheduled by time zones and shipped by way of air, and land. The typical delivery time within and outside Europe is between 24 to 48 hours (11). Zara also has an advantage over its competitors due to its low advertising costs. Zaras advertising investment is 0-.3% as compared to traditional retailers who expends 3 4% (13). Zaras cuts in advertising investments reduce total expenses, which make the international expansion more economical (16). This also signifies that Zara relies mainly on its stores to project their image. For that reason, Zara has a department, which exclusively works in acquiring global prime real estate locations. In addition, this department is responsible for the frequent refurbishing of store layouts, as well as the creation of a common window display for Zaras global 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. Zaras target market is very broad because they do not define their target by segmenting ages and lifestyles as traditional retailers do. Zaras target market is a young, educated one that likes fashion and is sensitive to fashion. Today, people around the world through various communication devices have more access to information about fashion. Therefore, fashion has become more globally standardized and Zara uses this to their advantage by offering the latest in apparel. For that reason, 80- 85% of the products that Zara offers globally are relative standardized fashionable products. This is due to the fact that Zaras marketing teams believe that a product that sells well in a fashion capital such as New York will most likely sell well in another 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 traditional retailers, it also has disadvantages that can affect its sustainable growth. Due its model, Zaras weaknesses also differ from the traditional retailer. Zara holds around 86% of Inditexs total international 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 great deal of capital into Zara. Inditex has contributed their extensive international sales to Zara and said Zara was the principal reason Inditexs sales were increasingly international (15). If Zara fails in the future, Inditex will have to totally re-formulate their firms strategies and may possibly face an internal meltdown. Zara also has an inability to penetrate the American apparel market. This may be due to American tastes that differ from European preferences. More importantly, however, Zara has not been able to develop a strong supply chain strategy in the U.S. like they have in Europe. Their European strategy includes, having a strong production and distribution facility in their home country in order to have short production and lead times. Zara has not invested in distribution

facilities in the Americas, which is a threat to their U.S. selling abilities since the U.S. makes up 29% 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 able to supply more retail locations due to their centralized logistics model (12).

Zaras strategy also 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 they 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 (David 145). Zaras speedy and recurrent introduction of new products incurs 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.
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 threat for the Spanish Zara chain. In July 2002 the euro was the only currency accepted for all transactions in member countries of the European Union (Euro). If the euro becomes stronger against the American dollar, than production costs will increase for European producers. The euro switchover will increase Zaras cost of production. That cost increase will be carried over to the consumer with higher prices. This threat of the euro may also create a threat of decreased sales because apparel prices will be too high for the traditional Zara shopper. Another threat lies with the quota elimination under the World Trade Organization agreement on textiles and clothing expiring in 2005. Traditional retailers who outsource goods can benefit from greater access to less expensive manufacturing. Zara will suffer from a high euro and the threat of its competition offering more inexpensive products. Zaras direct competition may be their largest threat, especially when expanding into new geographic territory. Almost any retailer can be a threat to Zara due to their wide range of merchandise 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 merchandise groupings. The Gap is one of these competitors because they are also international and sell the same range of merchandise with a less trendy style. H&M (Hennes and Mauritz) is probably Zaras 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&M also is more attentive when entering new markets and tends to enter one country at a time, as opposed to Zara who multitasks globally (5). H&M builds distribution centers in their international locations in order to cut down lead times and potential logistical costs. Another threat to Zara is that H&M carries trendy clothing choices that they have designed based on the melding of international apparel tastes. However, H&M offers these styles at a cheaper rate than Zara (5). H&M also uses more advertising than Zara, but not as much as the Gap, which may aid them in entering new markets successfully because the local customer is aware of H&Ms merchandise mix. A final threat to Zara is the issue of cannibalization. Zaras extensive location strategy involves putting multiple Zara stores that carry the same merchandise in the same cities. That means 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

each other especially if multiple locations are within the same city. Also, the other 544 Inditex stores located in Spain can cannibalize Zaras sales since the majority of the chains have a similar target market to Zara. This is similar to the challenges faced by the Gap versus Old Navy: Gaps sales were cannibalized by Old Navys lower prices (Lee). Recommendations The best way for Zara to maintain their sustainable growth is to seek new opportunities in the 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 seen recently. Zara should most likely develop a second central distribution center in the Americas to decrease logistics in order to deliver fashionable goods in a faster manner. Their second central distribution facility should be an expansion of one of their smaller distribution centers located in Argentina, Brazil or Mexico. The close proximity of the distribution center to the American market will allow them to effectively interpret the particular American fashion. The distribution center will also allow them to have additional funds to spend in other areas of business such as advertisements: a necessary feature to penetrate the American market. Another market opportunity for Zara is to invest in Internet retailing especially directed toward the U.S. market. Though Zara is wary of overexposure, Americans like to be able to purchase 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 a direct Internet selling strategy. That form of direct marketing will reach more consumers faster and easier. Though it may be difficult to display all of Zaras ever-changing fashions online, it may prove profitable for shoppers to purchase a moderate selection of trendy Zara pieces along with some of their staple basics. A final recommendation for Zara is to offer specialized products for different geographic locations within the same city. Zara already does this to an extent for different international preferences but more specialization will increase consumer demand and will motivate them to visit more Zara locations within their own region. In some cities the company is possibly experiencing cannibalization because there are too many Zara stores that carry the same product within one city. Zara could differentiate its product from location to location to increase shopper traffic. This would work because shoppers would hear about new/different products (possibly from word of mouth or increased advertising) that another Zara store is carrying across the city and they would be intrigued to pay a visit. That way sales wouldnt be stolen from their own Zara stores, decreasing cannibalization for the chain. In conclusion, Zara has the potential for sustainable growth due to its competitive advantage and its ability to face the challenges of the apparel industry. The company keeps its operating income elevated, has a strong and unique business model, and has various opportunities for expansion in the retail industry. To many Europeans, Zara is a familiar face with consistently trendy, well-priced new apparel every week. To Americans, it is a company that is just getting its feet wet in the American market. Though, the Inditex branch is researching and developing new methods for expansion, the company must continue to re-invent and innovate themselves in order to stay fresh in the apparel industry. Today, many companies are looking to Zara as the new industry standard for how to run a retail business, which shows that Zaras business model is becoming the wave of the future.
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