With which of the international competitors listed in the case is it most interesting to compare Inditex’s financial results? What do comparisons indicate about Inditex’s relative operating economics? Its relative capital efficiency? Even though H&M follows a strategy which differs significantly from Inditex’s approach it is the closest competitor from the financial point of view. H&M differs from Zara because it outsources all of the production, it is more price oriented and spends more money on advertising.
But both companies are based in Europe, are fashion forward at lower price retailers, and have a strong international expansion strategy. Exhibit 6 indicates that the financial results of Inditex and H&M seem to be very comparable. However, a closer analysis reveals that Inditex has enjoyed a competitive advantage in operating metrics over H&M. Some comparisons of financial and commercial parameters will help to understand the relative operating economics of Inditex (all numbers in € Millions). 1. ROIC = Return on Sales x capital turnover. Inditex: 27. 24%H&M: 24. 16% Inditex was the most profitable firm, measured by ROIC.
Return on Invested Capital is a key measure of a company’s profitability that focuses on the true operating performance of the company. 2. Operating Margin Inditex: 21. 7%H&M: 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 has a higher operating income by keeping cost of goods sold and operating expenses low. For example Inditex has a lower staff to store ratio which keeps the amount of money needed to be paid as wages low. Staff to Store Ratio: Inditex: 20,81H&M: 29,76
Additionally the company spends lower advertising expense than H&M. 3. Current ratio = Current AssetsCurrent Liabilities Inditex: 854834 =1. 023H&M: 1468432 =3. 398 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. This indicates that Inditex is less liquid which is probably due to the fact that the company has more fixed assets and a quick inventory turnover. But a high liquidity does not consequently mean high efficiency. H&M lacks a good strategy in using its cash. If its cash is not invested it will not generate a return.
H&M’s high current ratio may be the result of its excessive inventories because the firm does not own manufacturing facilities and products need to be stored in a warehouse. 4. Total assets turnover Total assets turnover = salestotal assets Inditex: 32502605 = 1. 248H&M: 42692183 = 1. 956 The total assets turnover indicates H&M is more efficient than Inditex but that may be the result of Inditex’s strategy of owning the stores and plants which tie up capital. In contrast to that H&M depends on outsourcing the production which leads to lower assets. 5. Operating expenses/sales Inditex: 9823250 =0. 02H&M: 16154269 =0. 378 The ratio of revenues by sales and operating expenses indicates the share in revenues used to cover the costs for running products, business and system. 30% of Zara’s net operating revenues are sufficient to serve operating expenses which means there are 70% left for counterbalancing production costs, taxes and other components. H&M cannot keep up with this because it offers its fashion at a lower price (reduces sales) and applies a more extensive marketing-strategy (rises operating expenses). 6. Success outside Europe Both companies have most of its stores located in Europe:
Inditex: 86%H&M: 96% But H&M is more dependent on the sales from its home continent: Inditex: 77% H&M: 96% Even though both companies have a strong focus on international expansion, Inditex is more efficient in exploiting the markets it has conquered outside Europe. Moreover, due to less stores and sales in the other areas rather than in the home country, H&M is less exposed to exchange rate variations which might explain the higher market value and lower size in total liabilities when they are compared to the figures of Inditex for 2001 Equity-Market Value: Inditex: 13,433H&M: 15,564
Total Liabilities: Inditex: 1,119H&M: 532 7. One Year Change in Market Value Inditex: 47%H&M: 8% Another factor which is interesting to examine is the One Year Change in Market Value. Inditex is on top position compared to all competitors with an impressive growth rate of 47%. H&M has the closest result and is the only company besides Inditex whose market value has been growing in 2001. Inditex’s efficiency is the result of a more profitable investment strategy. By owning all the stores and manufacturing sites it is able to achieve control over all production processes and costs.
The high number of stores may be also traced back to the increasing value of the property because Zara only buys stores in strategic areas (shopping malls, shopping arcades, pedestrian districts etc. ) where competition boosts rents. Therefore total assets of Zara increase as well. To sum up from the given information Inditex is more efficient in managing its finances. Its strategy of investing into high quality equipment such as a just-in-time manufacturing system, a huge warehouse close to its headquarter and an highly advanced communication system has lead to a Return on Investment rate of almost 23%.
This is a tribute to Inditex’s high capital efficiency. 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 price. 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 manufacturer’s selling prices. Zara’s competitive advantage is a result of an efficient production at low costs, good quality and a quick response to market demands.
An examination of different parts of the strategy will help to explain what makes the company more profitable than its competitors Zara’s business model, which directly affects its operating economics, can be broken down into Sourcing and Manufacturing, Distribution and Promotion. 1. Sourcing and Manufacturing: The most vital factor of Zara’s unique business approach is an in-house production system. The company fully owns 20 factories. It only outsourced the production of high labor intensive processes but maintained in house some other capital intensive processes protecting as well the knowledge and know-how.
By taking direct control of fabric supply, marking, cutting and final finishing Zara navigates its production throughout the entire value chain. The capital intensive vertical integration model into manufacturing combined with a highly labor intensive one has given Zara a competitive advantage. Inditex, the parent company owns a subsidiary (Comditel), which manages the dyeing, patterning, and finishing of gray fabric and supplied finished fabric to external as well as in-house manufacturers.
The result is “Fast Fashion”: A short lead-time is important for Zara to be able to offer the latest fashion in store at all time (just-in-time). This also requires a geographically close network so the company built up its manufacturing sites close to its headquarters. In contrast Zara’s competitors use to rely on cheap production in the Far East which boosts transportation costs. 2. Distribution Zara didn’t give any kind of license to any distributor. The self-owned centralized distribution facility consists of a high-tech information system to insure that clothes are stored only for a short while and to enable Quick Response.
Consequently it’s easy to manage scheduling, avoid conflicts, and reduce forecast variations / errors, minimizing the bullwhip effect and the necessity of Working Capital. Once the finished merchandise reached the distribution center it will be sent out immediately via shipments or aircraft by third-party delivery. Direct shipping from central distribution centers reduces cycle time and helps the company to be the first to market. Beside these benefits a centralized distribution facility keeps the inventory at a minimum and eliminates the need for further warehouses. . Promotion Zara is relying on the concept of its products’ scarcity and window displays rather than costly print campaigns. In contrast to its competitors Zara follows a strategy of minimal spending on media advertisement. Retail stores are set up in prime highly visible locations with rapidly changing, low-cost lines. Each individual retail outlet has the authority to select the fashion to buy or to remove from inventory. The responsible managers receive variable compensation to stimulate incentive for progress.
To summarize: Neither does Zara charge a premium price for its clothes nor does it want to become the lowest-cost producer in the apparel industry. It has rather developed a combination of differentiation and cost leadership. By limiting production from external parties and operating each step of the value chain, Zara is able to minimize costs and fees to third parties and maximize profits by creating a business model based on a Quick Response system and backward vertical integration.
Ultimately, the reduction in lead-times does more than improve the forecasting. It also decreases the level of inventory, which refers to capital locked up in stock, reduces the costs of holding and the risk of stock going out of date. 3. Can you elaborate the linkages among Zara’s choices about how to compete, particularly ones connected to its quick-response capability, and the ways in which they create competitive advantage? Zara’s competitive advantage refers to a quick response system composed of human resources and information technology.
The apparel retailer implemented its business model to deliver fashion items to consumers at the right time and place. Zara does not compete on price because the usual Zara customer is not very price sensitive. Quick response refers to a well established and syntonic communication between retailing and manufacturing. This gives the company the capability to respond quickly to market changes such as fluctuations in demand. This requires highly developed information technology software that transfers valuable information to and from the design team.
All production is received at the logistics centers for each chain, from which it is distributed simultaneously to all stores on a highly frequent basis. Zara stores epitomize a communication channel between the client and the personnel in both retail and manufacturing environments. In the fashion industry the customer’s demand changes rapidly. Therefore, to insure that Zara always offers fashionable clothes depends on good predictions of customer future preferences. This is the function of managers and sales associates that quickly report fashion trends back to the design team.
Additionally the product development team requires attendance at high-fashion fairs to integrate the latest trends into their designs. As a result, Zara can continuously refresh its stores twice a week comparing to its competitors that refresh stores once a season. The short cycle time reduced working capital intensity and enabled continuous product renovation, even during the biannual sales periods, which extended their season much later. Zara is spending the majority of the pre-season on raw material sourcing, design and production during the season itself.
This keeps inventory low and creates a “climate of scarcity” by putting pressure on clients to purchase clothing quickly because it might run out soon. Its quick response system gives Zara the capability to respond to market changes efficiently and to sell products faster than its competitors. Zara’s strategy of how to exploit QR-facilities is the reason for its competitive advantage since competitors such as Japan World Co. use QR-methods as well. But they failed to success because they lacked the ability to profit through constant variation in design inside their target market.
In a nutshell, Zara has truly differentiated itself with its “fast, affordable and trendy fashion” while avoiding the decline stage of the product life cycle with innovation and consumer integrated collections. 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? Zara’s plan to expand internationally could be a possible threat of failure to Zara because its standardized production line and strategy is limited to the current geographical base in Europe.
Companies are facing differences in the economic, cultural, social and political conditions in each of the regions and countries they are expanding into. Differences in tastes, price sensitiveness and attitudes toward fashion across regions can also cause Zara to succumb in face of harsh competition and its alleged “diseconomies of scale”. With only a few large distribution centers the company risks facing high shipping costs and slower delivery. Consequently it will lose its image as one of the most efficient apparel enterprises. Additionally, its reliance on in-house manufacturing may become too costly.
Thus Zara may has no choice but to outsource inventory. Hence, to enter international markets, Zara needs to deliver its apparels in-time, at competitive prices and adjust strategies and product lines on a country/region basis to be able to effectively serve the local demand without incurring additional costs. Another threat of failure that lingers Zara is their inability to develop a strong supply chain in the Americas. The U. S apparel market covers 29% of the world’s market. Due to its success in Europe Zara now has the ability to grow.
However the company lacks the essence of strong internal production and distribution facility, producing in small batches, and delivering in short-lead times in international markets outside Europe. In contrast to Zara, The Gap and H&M have been able to expand to North America which represents a market of retailing overcapacity and a less fashion-forward market. If Zara is unable to capitalize on the US market it might fail. But if the company continues to count on its specific competitive advantages, its potential for growth seems to outweigh that of its main competitors.
These weaknesses do not necessarily lead to an inability to expand internationally. But some of the previous strengths may be weakened as a result of increased internationalization by competitors and lead to less successful operations than the company has experienced yet. When it comes to the expansion into the US apparel market there will be another possible threat for Zara: changes in foreign currency market. If the Euro becomes stronger against Dollar production costs increase which lead to higher prices of apparels to final customer. Direct competition is one more aspect leading to a potential failure of Zara.
The common goal of its competitors is to enhance their global growth opportunities. H&M’s strategy of entering one international market at a time and designing clothes based on international tastes is also worth mentioning. Zara’s closest competitor is currently building distribution centers in their international locations to save on lead time, transportation, and logistics costs. H&M offers slightly lower prices and concentrates on specific target markets. But The Gap, for example, performed poorly in supply chain management and clear fashion positioning.
Zara is still not focusing a specific market by creating a crystallized image of the ideal “Zara-Style” which may hinder its movement and growth in international markets. The markets are diversified, have different requirements and tastes, the industry structure is different, and it may be difficult for Zara to impose its existing structure in foreign countries unless it understands the markets. 5. Was Galicia/Spain fertile ground for the emergence of an apparel retailing powerhouse? Galicia was considered the third poorest of Spain’s independent regions. The inhabitants relied heavily on agriculture and fishing.
There has been a lack of communication links, technical institutes and universities to facilitate specialized training. Due to the lack of strong local demand for apparel, strong base upstream in textiles and sophisticated local demand other entrepreneurs might have chosen another region to settle down. However there have been several advantages for Zara’s founder Amancio Ortega to establish his business there: 1. Attitude towards apparels: Historically, Galicia had always been well versed with apparels and famous for its apparel quality. The area has been the home to thousands of small apparel workshops.
Galicians were considered as tailors to aristocrats. 2. Work Force: In such a poor region labor cost have been lower than in the rest of Spain. Due to a high unemployment rate in Galicia the company would not find any trouble attracting employees to join Zara. 3. Location: The region of Galicia has also a very important advantage of being in the corner of Europe from the perspective of transportation costs. On the bottom line by reducing transportation costs and employing labor at cheap rates Zara was able to benefit from the region. Even though Galicia has its limitations, the advantages clearly outweigh the drawbacks.
Hence it was definitely a fertile place for apparel retailing. 6. How well does Zara’s advantage travel globally? As indicated in this case study Zara’s international sales accounted for 86% of Inditex’s sales from abroad in 2001. 61% of its sales came from abroad. This shows that the company had managed to travel globally successfully. By adapting to each culture, Zara has managed to position itself differently in different markets. To obtain insight of the local market and how best to adapt to it Zara opened one store for information gathering in the initial phase of entering a new market.
Such an “information gathering” store helps to avoid additional expenses and to meet the direct demand of the consumers. Zara was able to expand in respect to its own limitations. Firstly, it did not immediately expand to “hot spots”, but it rather entered one country per year until the company was able to accumulate funds and committed time to growing venues. The management describes this style of expansion as “oil stain”, which refers to starts in major areas followed by the dispersal to smaller neighbor regions. Zara has expanded successfully in Europe with its largest store in Milan, Italy.
Zara’s success concept seems to work out best in regions of a more fashion-forward culture. North America and Asia epitomize the next logical retail locations, but there are already too many apparel retailers in both continents and Asian and North American customers are considered less fashion-forward. Additionally Zara needs to adjust its products to these new markets since for example the average apparel size of the US differs from the European proportions. To summarize, Zara’s approach was very strategic in the way they opened new stores in foreign countries in terms of ownership – ranging from company-owned franchise and joint ventures.
Essentially, Zara’s management avoided huge risks, but rather made sure to keep familiarity and relatively easy markets in mind when expanding globally. With the upcoming expansion into additional countries and new markets, competitive advantages should be adopted to the special circumstances relevant to these areas. 7. What do you think of Zara’s past international strategy? Evaluate, in particular, its past strategy for (product) market selection, its mode of entry, and its standardization of its marketing approach.
Internationally, the strategy Zara adopted was to test the market by flagging one store then expanding according to market needs. A well balanced mixture of standardization and customization stimulated growth of the company and eliminated several risk factors. When it comes to standardization it followed standard procedures in selecting and entering a certain market, which made scaling operations easier. Zara prefers to expand into countries with similar or if not, favorable micro and macro economic conditions.
The standard procedures left room for customization required by different cultures and countries, for example different entry modes, items suitable for the market and brand positioning. Moreover, Zara initially selects countries in concentric groups to avoid shipping problems evolving with the complexity introduced by a certain range of distance. Before making the entry decision, Zara’s commercial teams carefully studies the target markets. Once these teams found a favorable market Zara would immediately expand to reach economies of scale after setting market-based prices.
This systematic procedure to insure extensive market testing before expanding is also called the “oil-stain” method. Outside of Spain the company adopted 3 different modes of entry that depended on local factors: Company-owned stores, joint ventures and franchises. Franchised operations were controlled by strict QA procedures and the company provided extensive free services to its partners (human resources-training-logistics). Zara always retained the right to open company-owned stores and the option to buy out its partners in case of problems.
This is, as already mentioned, a good strategy to maintain control of a vital factor of Zara’s business. The image Zara created over the years minimized the need for any marketing activity and the flagship store, based on a prototype, in each market was used to verify data about market conditions while pricing differed according to shipping cost, taxes and tariffs. Marketing decisions varied from one country to another thus reflecting the different parameters and challenges. For example in terms of brand positioning Zara had to adjust to the local purchasing power and taste. The apparel items reflected local preferences and measurements.
I think in contrast to the advantages of the international expansion policy, Zara’s price policy especially regarding the United States should be reconsidered. The price of Zara products in USA is more than double same products in Spain. In a market with so many retailers customers are not quite flexible. If other retailers outcompete Zara’s prices they will soon change to competitors. Additionally, as the case study stated, “what worked with1000 stores will not work with 2000 stores” and the centralized supply chain might collapse or become a real problem in the wake of Zara’s global expansion.
Consequently, competitor such as H&H might find a window of opportunity in that sense. Ultimately, I consider the company’s uniformly fashion as a risk. Although it is successful in Europe, yet it might not be the case in Asia or North America. In future the company will need to adopt more local customization when entering new international markets. 8. What is the best way to grow the Zara chain? How, specifically, do you see prospects in the Italian market? And more broadly, what do you think about the strategy of focusing on Europe versus making a major commitment to a second region?
The deep level of vertical integration makes business operations very complex with multiple sources of production and assembly that goes to one centralized distribution system. That is why Zara should procrastinate an expansion to Asia and North America. It is not equipped yet to increase complexity by expanding into such huge markets. Moreover, many strategies and changes have to be considered especially in production and logistics before venturing into new markets. Zara has reached a stage where its centralized distribution system will soon cause diseconomies of scale.
Scaling the distribution system and shipping to new far-away markets with different needs will be hard, if not impossible to manage. 1. Short term strategy: The next step to grow the Zara chain at this point of its development is to focus on the rest of Europe since it is not fully exploited to its potential. There is a low retail chain concept in markets such as Greece, Sweden, and Italy which makes room for entrants like Zara to get a foothold in the market. Italy epitomizes the most interesting target market in terms of fashion consciousness and shopping habits of the customers. Italians pent the highest per capita on apparel and they are also considered very fashion-forward which fits well to Zara’s fashionable designs. The strategy of approaching further European markets is generally the recommended strategy for Zara. The company understands the dynamics of the European market since it was founded here. Furthermore it is capable of entering the Italian market without the need to make major changes or adjustments to its operations. The advantage of proximity to its warehouse and distribution facility will help Zara operate better and faster than any of its competitors.
However, Zara will need prime locations for its retail stores if it plans to keep the advertising to minimum. Since all major European markets would have heavy presence of competitors, it would be beneficial for Zara to reconsider its current strategy in terms of store ownership. Hence, Zara can either outsource its retail stores to interested franchisees or it can form joint ventures in order to maintain greater control. Another possible approach is to continue to own its flagship stores and franchise other stores with the intention of buying them out when they increase their market share. . Long term strategy After expanding to the Italian market Zara should restructure its production and distribution system before attempting to tap into the Asian market as it is a huge market that would require abundant resources. The initial costs will be extremely high and Zara will have to spend large amounts to get the preferred brand image. Moreover, there will be tough competition from such markets due to low cost of productions and low price of apparels. This front will be difficult for Zara to bear with. The North American market suffers from retailing overcapacity.
In contrast to Zara’s current marketing strategy, many retailers are competing there mainly on price and discounts. Hence, it is not a strategic priority for Zara. The American consumers have a less fashion forward attitude, they demand larger sizes and the operating costs will be higher. However it is an attractive market on the long run as Zara would be able to out-compete other companies thanks to its outstanding financial successes, its information systems, its marketing teams and its ability to update itself with latest trends and fashion. 9.
What other strategic recommendations would you make to Inditex CEO Jose Maria Castellano? In addition to recommendations regarding its strategy of expanding to further markets as indicated in question number 8 the Inditex CEO should consider a more decentralized production by setting-up facilities beside major clusters of countries. Due to its fast expansion Zara’s supply chain is becoming more complex. Hence, its production and distribution system needs to be extended and restructured to avoid a state of diseconomy of scale and to cater for the demand of each cluster.
Zara’s logistic center in Arteixo will soon meet its limits. To prevent choke points further distribution sites should be set up. This will enable Zara to be faster, more effective, and more efficient in distributing their products to the retailers. On the other hand Inditex’s chains could become more centralized. By centralizing, or at least creating a common party to handle all supporting function for the different chains, Inditex can make huge savings, hence, economies of scale.
In example combining purchasing, distribution, warehousing, and other supporting functions, like financing, IT, etc of the different chains would save time and prevent the need of redundant work to be done independently. Consequently I would not recommend the acquisition of any additional chains but a focus on expanding the current operations. In the wake of globalization scores of companies, not just in apparel industry, outsourced their production to China and other low labor cost countries.
Given this, Inditex should consider buying more from China further reducing their cost of goods sold. Moreover I would recommend to gradually integrate a new IT system into the company to avoid the risk of the current system becoming obsolete. A continued change of the information system is less costly and provides time to test the new technology. The main target of this strategy is to improve the efficiency of decentralization which requires a high developed platform to exchange information and to analyze data such as demand changes, production orders and sales numbers.
But an “up-to-date technology” must go hand in hand with an “up-to-date personnel”. The company must invest in education and teaching of the staff to be able to use new IT-systems to their full potential. Additionally the success of each individual apparel store depends heavily on each store’s manager. Zara may be interested in creating and investing in an internship/co-op educational program to train potential candidates. This
