Zara's Business Operations and Strategy - How and Why it Works
Inditex is the world’s largest clothing manufacturer. Beginning in 1974 as the very humble Amancio Ortega Gaona’s clothing shop, Inditex has grown steadily for years. Today, Inditex manufactures more than 840 million garments annually via 6,300 stores in 85 different countries. Those statistics will be reshaped in short time, however, as Inditex adds to its collection of stores at an astounding rate of 500 stores per year.
In a recent interview, Inditex spokesperson addressed Inditex’s remarkable expansion and concerns over its sustainability: “‘It depends on the customer and how big the demand is. We must have the dialogue with the customers and learn from them. It’s not us saying you must have this. It’s you saying it.’” (Slate Magazine 2014) Indeed, demand for Inditex products and designs are fueling Inditex’s expansion. But what is fueling the demand for Inditex products? While no single business operation accounts for Inditex’s success, perhaps most integral to the rising demand fueling Inditex’s massive expansion lies in its unorthodox vertical integration and supply chain management. But again, Inditex does more than one thing differently that enables it to stand out in the retail clothing industry. In this paper, we analyze the operations vital to Inditex’s success including vertical integration, supply chain management, comparative advantage and competition, key success factors, strategy, and philosophy.
“Through its business model Zara aims to contribute to the sustainable development of society and that of the environment with which we interact”. Interestingly, Zara’s (Inditex) mission statement here makes no mention of clothing – either directly or indirectly. Instead, it introduces three salient components of Zara: the business model, the environment, and society at large. The former appeals to Zara’s unique strategy. The latter two elements highlight Zara’s appeal to environmental sustainability (as evidenced by various initiatives in their product design and distribution) and a sustainable society.
Having been conceived in the relatively volatile Northern Spain, perhaps the sustainable society bit included in the mission statement intimates a desire for tranquility, integration, and general welfare. While it cannot be said whether or not Zara is successful in creating a greater general welfare in the societies it touches, it can be said definitively that it influences a great number of societies. From China to the U.S. to Europe to Brazil, Zara reaches vastly different cultures. Given the success of Zara in these markets, and knowing that each transaction is engaged in voluntarily, it can be said that Zara has at the very least provided a product at a price many find agreeable. Whether or not this creates an increase in general welfare is hard to say.
Zara’s commitment to environmental sustainability is readily identifiable. According to Zara’s official website, all Zara stores have managed an average 20% reduction of electrical consumption in recent times. Recycling efforts of furniture and decoration, organic manufacturing processes, and biodiesel fuel all contribute to Zara’s environmentally friendly image. You can see in Chart 1 below, Zara’s environmentally conscious philosophy bears out in its waste management. While the number of garments manufactured by Zara (in blue) has increased steadily since 2008, industrial waste (in green) has decreased or maintained very low levels.
In sum, Zara’s mission statement does reflect the companies prevailing sentiments. And it underlines its cost cutting strategy as it relates to sustainability. Still, Zara’s mission statement lacks a holistic approach, not including vital linkages to help customers understand its mission in the context of its business. Including more elements on how Zara, as a clothing manufacturer and retailer, commits to sustainability is in due order.
2 + 1 Strategic Approach to Operations
Zara’s mission includes little to give the reader a sense of what Zara is and what distinguishes Zara from the rest. These elements might be collectively known as Zara’s overall business strategy. Two key components make up Zara’s distinctive strategy.
Firstly, Zara is vertically integrated. It manages design, production, shipment, display, promotion, sales, and feedback itself, relying only diminutively on outsourcing. This vertical integration approach gives Zara a lot of control over how it operates. In turn, Zara leverages this control into precise data acquisition and forecasting, seamless modifications, and reliable quality in its products. Being vertically integrated also enables more fluid communications between stages of the Zara product cycle: design, manufacturing, transportation, etc. This being a sort of subset of the control advantage, Zara has a distinct advantage in its ability to create efficient supply chains.
The vertically integrated strategy comes at a cost, however. Competitors can book factory space in advance abroad for less money and with greater production assurances. Zara manufactures most of its products in Europe where it is more costly.
However, an overwhelming majority of Zara’s sales are in Europe. According to Zara’s official website, sales by geographical region show Europe with 66%, Asia with 20%, and America with 14% of sales. Outsourcing to Asia necessitates very costly transportation costs back to its biggest market. Therefore, by keeping manufacturing at home, Zara circumnavigates this cost. Something many other clothing retailers simply cannot replicate because they rely so heavily on cheap manufacturing labor from Asia.
Control over design and manufacturing by keeping manufacturing processes close to management centers also makes garments both higher quality and easier to manipulate. Not only are European workers more skilled, European capital equipment is more precise. The confluence of better capital equipment and more adept employees results in higher quality garments. Moreover, vertical integration and locating manufacturing close to markets enables Zara to manipulate designs and churn out new ones very quickly, introducing Zara’s second most important strategy.
Product Replacement Cycle
Because Zara manufactures its products in Europe, it can very rapidly change designs to accommodate dynamic demand for various styles. This relates closely to Zara’s lightning-fast product replacement, unparalleled in the industry. Fast product replacement does two things for Zara. First, it enables Zara to adapt to consumer demands quickly, aligning itself with demand in a meaningful way. And secondly, it encourages customers to buy in a timely manner because the particular product or design that strikes your fancy today may be replaced by something else tomorrow.
“In Zara, every purchase is an impulse buy…You are buying clothes not because you love them, but because [they are] likely to be gone in a matter of days.” (Suzy Hansen 2012) While this quote does highlight Zara’s low-inventory strategy (to be talked about next) and its rocket-fast product replacement cycle, it may miss the mark on the experience Zara creates. Perhaps impulsive buys are something common at Zara stores, and perhaps Zara wishes to create such an environment; but customers keep coming back for more Zara products. So this statement might wax unrealistic as sentiments usually indicate customers are happy. Many report the quality of Zara products to be quite good compared to others that offer similar, but much more expensive products – like Armani, Gucci, or Prada. And as we explored early, there may be some vertically integrated evidence to back that assertion up.
Low Inventory Strategy
Moving on, while vertical integration and product replacement highlight two of Zara’s strategic and very unique approaches to retail fashion, there exist many other stratagems that merit mention. Perhaps linked to the fast product replacement and turnover that makes customers think “I need to buy this now!” is Zara’s artificially low inventory environment. The idea is that low-inventories create a sense of urgency among customers. They think: “I had better buy this dress because there are only two left!” Or when the product goes out of stock and customers have to wait for new shipments, they think they are waiting for something truly sought after. While this amounts to something like a psychological ruse, low-inventories enable Zara to decrease the number of price reduction events (“sales”).
Increased Margins & Psychological Ruses
Fewer sales translate into increased margins. You can see from Chart 3 above, the quantity of products Zara discounts pales in comparison to other retailers. If products are discounted to remove excess inventory, customers may look for discounts in the future, delaying purchases. Therefore, Zara manages to increase margins for the products it does sell while simultaneously adding to its list of psychological tools. But does this multilevel psychological game really increase profitability? According to recent data, the answer is yes. Zara limits inventories, but not at the expense of profits. In Chart 4, you see total revenue in billions of dollars between 2003 and 2007 for 4 major clothing retailers. In Chart 5, you see profits during the same time frame for Zara and Gap, its biggest competitor.
Gap continues to sell many more garments than Zara. But in comparing profitability, Zara appears to be the decisive winner.
Key Success Factors
Vertical integration seems most fundamental to Zara’s success because it enables many of Zara’s periphery stratagems. For example, rapid product replacement cycles relate closely to vertical integration. Without close communication between supply chain units, rapid product replacement cycles would be impossible. With that, rapid product replacement cycles themselves enable other stratagems.
Proprietary Software and Design Flow
Zara uses proprietary software to analyze fashion trends from each of its many hundreds of stores around the world. This proprietary software, on top of a specially trained professional work-force to do the same, capitalizes off of Zara’s rapid product replacement cycles by cataloguing in real-time which products are being purchased, in what quantity, and where. This enables Zara to realize the newest fashion trends. Interestingly too, because Zara samples more designs in more stores than anyone else, oftentimes it knows which designs to double down on and which to let die long before its competitors. In this way, Zara really distinguishes itself by reversing the usually flow from design, manufacturing, transport, and then to the customer; putting the customer first instead.
Synergy Between Strategies
This idea of Zara being able to sample products before committing to them is also related to Zara’s low-inventory strategy. Rapid product replacement enables Zara to sample many different designs; however, low-inventories allow Zara to do this absent waste. If other retailers were to try Zara’s approach without 1) vertically integrating and bringing manufacturing closer to markets and 2) reducing inventories, they would likely experience profitability loss as manufacturing and transport costs add up and excess inventories reduce margins. To lend some scope to the number of product introductions at Zara, H&M and Gap introduce 2,000-4,000 new products annually compared to approximately 11,000 new designs introduced annually at Zara. Furthermore, average inventory holding at Zara is 6 days compared to 52 days at H&M and 94 days at Cortefiel.
The synergy between Zara’s individual stratagems makes it difficult for competitors to copycat. Established competitors like Gap and Gucci would have to completely reinvent themselves to successfully mimic Zara. It seems only newcomers have a real shot at replicating Zara’s strategy. Still, Zara’s scale keeps many of these start-ups from competing and many others from expanding into Zara’s territory.
In line with Zara’s high-fashion-at-a-low-price mantra, Zara’s location strategy does not lack grandiosity. “The retail strategy for luxury brands is to try to keep as far away from the likes of Zara. Zara’s strategy is to get as close to them as possible” (Suzy Hansen 2012). For Zara to successfully compete with luxury brands, it must first identify with customers as being a luxury brand. Zara’s location strategy might be credited with its success in this regard. Zara’s strategy is to project high-class fashion from all of its retail locations and to do so right next door to its luxury brand competitors. For example, in Istanbul Zara “can be found one street away from Cartier, Hermes, and Chanel”, three very expensive brands (Suzy Hansen 2012). Zara likes to distinguish itself, too, by establishing stores in unique settings such as the San Antonio el Real, an 18th century convent in Salamanaca; a historic cinema in Elche, Spain; and 666 Fifth Avenue in New York. The latter reportedly cost $324 million – the most expensive piece of real estate ever sold in Manhattan (Suzy Hansen 2012).
While through its location strategy Zara does not shy away from extreme expense to project a wanted image, Zara does not advertise. Zara’s advertising is limited to its catalogue and its logo on retail store bags used to carry out purchased items. While this may not have much relevance to business operations, analyzing Zara’s advertising lends some understanding of Zara’s overall philosophy and strategic approach. Especially how Zara leverages very sophisticated psychological tools into increasing profits.
Perhaps Zara’s lack of advertising reflects its desire to eschew thriftiness and establish an aura of quality, luxury, and class. More specifically, Zara could be counteracting natural human psychology that identifies more expense with greater quality and prestige. Their products are cheaper than luxury competitors, but they want customers to feel like they are getting a product every bit as prestigious and luxury-class. Lastly, as much as Zara is grandiose in its real-estate investments it is equally selective. Zara considers only markets that promise strong demand for its products. Considerations prior to market entry include local taxes, political condition, tariffs, local competitors, demand, location, regulation, and supply chain.
Zara really is heads and shoulders above many of its competitors, and approaches retail fashion in a unique way. However, some of its strategies have shortcomings. For example, low-inventories fail to accommodate high demand for a product. While Zara is fast at responding to demand by ramping up manufacturing, it cannot match high-demand in a short period of time. Sometimes high demand for various fashion items wanes very quickly. At Zara, such parabolic demand would often result in lost profits.
High product replacement also carries risks. While multiple product offerings can be useful in determining trends and aligning designs with demands, sometimes products can cannibalize each other. In other words, introducing a new product may limit the success of another product that would have otherwise done well.
How to Decrease Risks
For Zara, their strategy has been quite successful. However, in order to decrease the risks outlined above, Zara might consider new technologies to anticipate parabolic demand. For instance, algorithms that combine the rate of sale of various products as compared to similar products during same seasonal cycles could yield caveats enabling Zara to adjust manufacturing before peak demand is reached. In a sort of proactive way, technology, already readily implemented at Zara, could be expanded to connect preliminary data points and offer forecasts.
Also, Zara’s vertically integrated approach does well to concentrate manufacturing, design, and supply chains close to its markets. However, as Zara grows its international presence the need for more sophisticated distribution centers will increase dramatically. They must weigh the benefits of scaling markets with the prospects of them losing some of the strategic advantages that enable them to do so. As Zara only has one large distribution center in Spain, more distribution centers around the world will be required in short time, especially if they continue expanding at a rate of 500 stores per year.
Zara’s founder, Amancio Ortega Gaona’s, is known for his reclusive personality and aversion to media outlets. He takes pride in what he does and the company that he has cultivated. And in Zara’s success, Gaona has become the world’s third richest man. But Gaona is humble. In some ways, Gaona’s character is reflected in Zara’s approach. It does things differently and has been very successful because of it. But Zara is not reactive in the same way that other retailers are. It considers its strategy carefully and has a long-term approach.
Certainly, Zara presents a beautiful case analysis of interesting strategy and business operations. And how the latter can be vital to far-reaching success.
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