Zara

Group 8: Chengjiao Gan, Kenneth Chua, Weishu Mo, Yuchen Cheng

Q1) What makes Zara different from other retailers? The following factors distinguish Zara from other retailers: Shorter lead times for design styles to reach the market Smaller quantities per style More styles during a year Underlying these factors are numerous business elements that are intertwined: Accelerated Product Development and Market Research The heavy creative workload of 11,000 styles a year is managed by a design and development team of over 200 people, all based in Spain. The designers work in central, open spaces at Zaras headquarters, alongside with store specialists who review daily updates of store sales and speak to store managers to gather informal feedback. Each store manager feeds back market information from the stores as well as his or her sense of prevailing market trends, which are incorporated into the designs. Traditional daily sales reports can hardly provide such a dynamic, updated picture of the market. React Rather Than Predict In the fickle world of fashion, even seemingly well-targeted designs could go out of favor in the months it takes to get plans to contract manufacturers, ramp up production, and then ship items to warehouses and eventually to retail locations. Rather than concentrating on forecasting accurately, Zara has developed its business around reacting swiftly. Most apparel retailers commit about 40% to 60% of its season inventory six months in advance of the season, compared with 15% to 25% for Zara. By the beginning of the season, about 80% is committed by most apparel retailer; Zara committed only 50% to 60% of production in advance, with the remainder manufactured on a rolling basis during the season. It was the in-house portion of the in-season production that could be easily modified in response to market demand. Assuming it had fabric in stock, Zara could go from start to finish on a style production in as little as 10 days. Vertical Integration The firm is able to be so responsive through a combination of vertical integration, just-in-time manufacturing, and finely-tuned logistics. Zara has various business elements in close proximity to each other, around its headquarters in Spain. Most retailers almost completely outsource their
Page 1 of 5

production to factories around the world, many of them in low cost Asian countries. In contrast, about 60% of Zara's production is carried out in Europe, much of it within a small radius of its headquarters in Spain. In fact, Zara is so vertically integrated that almost half of its production is in owned or closely-controlled facilities, including up-to-date equipment for fabric dyeing and processing, cutting and garment finishing. It does not own the labour-intensive process of garment sewing, but controls it through a network of sub-contracted workshops in Spain and Portugal. For distribution, Zara adopts a hub-and-spoke approach. All of the items the firm sells end up in a 500,000 square foot distribution center in Arteixo, which serves as the hub. The facility move about 2.5 million items a week, with no item staying in-house for more than 72 hours. Shipments were made out of the distribution center to its spokes regularly so that within Europe, stores received goods within 24-36 hours of shipment; outside Europe, it was within one to two days. Keeping Costs Low In terms of marketing costs, Zara relies more on word of mouth rather than advertising. Typical expenditure for retail advertising is 3% to 4% of sales; at Zara, its a meager 0.3%. Furthermore, as a result of Zaras strategy to produce styles at low volumes, the need to mark down leftover merchandise is correspondingly reduced. Zara experienced 15% to 20% markdown sale of season volume, compared with 30% to 40% for much of the industry.

Q2) Where are competitive threats to Zara likely to come from? Internal Zara is unequivocally strong in Europe as its headquarters and distribution center are based in Spain. Nevertheless, it is this strength that could become their biggest weakness in its plan to expand internationally as they do not have comparable set-ups in locations outside of Europe. If Zara wishes to replicate its business model so as to deliver its apparels, customized for local market, at competitive prices and on time, it would probably have to set up a regional headquarters-cum-distribution center in a location outside Europe. A possible drawback to setting up a such center is that this would result in an additional layer of bureaucracy, which would slow down response to fashion changes. Customer Significant differences in political, social and cultural conditions in other countries could pose a threat to Zaras expansion ambitions. Similarly,
Page 2 of 5

variations in taste, preference and fashion sense across regions and countries is another threat that Zara cannot ignore. To address that, the firm would most likely have to carry out market research in the local market to better tailor their designs to local tastes. Another threat that Zara faces is that it has not made inroads into the BRIC (Brazil, Russia, India and China) countries, except for Brazil (albeit a paltry 5 outlets based on Exhibit 5). Given that the BRICs are developing rapidly and that it is projected that they could become dominant economies by 2050, it is crucial that Zara establishes a foothold in those countries so as to ride their expected rising affluence. In addition, movements in foreign currency can also be a possible threat to Zara. Production costs may increase if Euro strengthens against foreign currencies, resulting in higher prices for customers outside of Europe and correspondingly lower revenue for Zara. Competition Other retailers, such as H&M, The Gap and Benetton, are similarly looking at international markets to enhance their growth opportunities. H&M comes closest to Zara in terms of price and fashion sense. H&Ms strategy of entering one international market at a time and designing clothes based on international tastes is also a commendable one. H&M is also in the process of building distribution centers in their international locations to save on lead time, transportation costs, and logistics costs. Furthermore, Zara will have to keep its eye on the horizon for retailers from emerging markets such as China and India. If they were to emulate Zaras business model, ceteris paribus, their low labor cost could give them the edge over Zara.

Q3) What should Zaras approach to determining its sourcing mix? What assumptions are you making when you reach your conclusion? In-house vs external In Zaras production sourcing structure in 2000, about half of its production is made in-house while the other half is outsourced. The in-house production has a very short lead time, so it is usually committed after the beginning of the season, and it is mostly focused on current(in season) production to meet the changing demand in the season. As for third-party sourcing production, the commitments for production are roughly six months prior to the scheduled store delivery and garments are more heavily weighted toward basic items and the initial fashion collection.
Page 3 of 5

There is a tradeoff between in-house and external sourcing. External sourcing especially outsourcing to China and other developing countries can benefit from a lower labor cost, and sometimes more security due to fixed contracts, but it will also suffer from a longer lead time and a lack of flexibility and responsiveness, which is very important to meet the ever-changing tastes of consumers. Different origins of production The outsourced locations are depended on a lot of various factors, including raw material quality and availability in the country, whether the labors meet the skill requirement, and transportation time and cost. Also the complex system of quotas and tariffs impacts the cost of production and may result in distortions in the supply chain. Approach Therefore, the proper approach should take all of the above factors into account, and give the best allocation between all sourcing locations. So Integer Programming is a good approach for Zara to optimize its profit. In the IP model, decision variables are the number of products produced in every location. Constraints are cost constraints, time constraints, skill constraints, non-negativity constraints and other constraints. So the solution to the IP model will be the best sourcing mix. Q4) Zara appears quite successful. Why dont other retailers copy their approach? Business Elements are Intertwined Underlying Zaras success are numerous business elements that are intertwined and not easily replicable because each element is not only dependent on other elements, but itself is also integral to the success of others. For instance, the firms ability to respond to fashion changes promptly is made possible only by a vertically integrated manufacturing, supply, distribution and retail system. This in turns enables it to keep its costs low because unpopular styles are quickly taken off the production line, lowering the need to markdown leftover merchandise. If retailers wish to replicate Zaras approach, it would need to overhaul their business model which is going to take time, a commodity that is not aplenty today. It is so that we see that Zara has a sustainable edge in the foreseeable future. Closely Controlled Vertical Integration The firm is able to be so responsive to fashion changes through a competitor-crushing combination of vertical integration, just-in-time manufacturing, and finely-tuned logistics. Zara is so vertically integrated that
Page 4 of 5

almost half of its production is in owned or closely-controlled facilities. It does not own the labour-intensive process of garment sewing, but controls it through a network of sub-contracted workshops in Spain and Portugal. Shipments were made out of the distribution center at Arteixo regularly so that within Europe, stores received goods within 24-36 hours of shipment; outside Europe, it was within one to two days. To replicate Zaras approach, it would require other retailers to set up a vertically integrated system that allows a seamless process for processing, cutting, garment finishing, sewing and distribution. In other words, this would require the big retailers, such as H&M, to reverse their strategy of close to100% out-sourcing. Such a shift would not only be costly, but also a momentous decision. Leveraging Human Judgment Human judgment is a key ingredient to the firms success. This is best illustrated by a typical decision that Zara makes: the firm might have an item that is selling well, but it could stop manufacturing it to deliberately create unsatisfied demand. While this is not rational from an economic perspective, Zara hopes to create an uncertainty in demand that will spur customer to purchase their apparel now, rather than later. To make such a spot-on decision, it requires intimate knowledge of consumer trends which can only be accumulated through observing the industry over a period of time. This intangible aspect is another area that other retailers may find it hard to replicate in a short period of time.

Page 5 of 5