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Walking down Lexington Avenue in Midtown New York, the strand of high-end clothing brand name stores is seemingly endless. But there is one store that sticks-out somewhat amongst the fashion icons. The Zara store welcomes visitors with inviting windows and an open store layout that is only trumped by the fresh fashions and affordable price tags occupying the shelves. Zara Inc. is the flagship brand of Inditex, a European conglomerate of name clothing brands. Zara stores have become commonplace in fashion centers outside of the company’s home country of Spain. Known for their youthful styles and bright, inviting stores, Zara has taken the fashion and financial world, by storm.

Zara operates a vertically integrated business model in an industry known for outsourcing, controlling both their production and distribution in-house. The result is that Zara has control over its entire supply chain, resulting in a rapid offering of new styles while retaining affordable pricing for consumers. Zara’s business model encourages store managers, employees, and fashion-conscious staffers to identify fresh styles first and quickly push them into evaluation. If a style fits with the company’s target consumer markets, Zara can almost immediately begin to manufacture new clothing because of their vertical integration. The result is that Zara is always on the cutting edge of style. Financially the results have supported the company’s strategy, as sales have boomed to 8 billion Euros in 2010, up from 7 billion in 2009, and the company has even loftier goals in the coming years.

New Challenges

While Zara has excelled in Europe and the Western Hemisphere the world is calling for Zara to spread its wings outside of its traditional markets. Seeing this opportunity, Zara has established some lofty goals for growth. Even during the global recession, Zara grew its business by opening up 95 new stores worldwide.1  Zara recently opened up a store in India and Australia, and will soon enter South Africa, Taiwan and Peru. While there is ample opportunity in rapid growth there are also opportunities for serious blunders. Zara now has a set of new strategic challenges.

Zara has performed well in its current markets, which make-up 66% of the EBIT returns for Inditex. This is a substantial portion of the parent company’s earnings however future opportunities for the company are clearly in the developing markets of Asia and the eastern hemisphere. Zara’s footprint places 72% of their stores in Europe and the Americas, and yet the growing consumer base is in Asia where only 13% of their stores are currently located.
In order to penetrate these new markets, Zara must be strategic in executing their current business model abroad. While vertical integration worked extremely well for Zara in Europe, their existing distribution system will not extend efficiently into new markets. The sheer distance between their operations in Europe and the markets of the eastern hemisphere add real logistical complications, but more importantly, different cultures and trends will pose dramatic challenges. Zara will need specialized teams to study local markets so they can better pinpoint local trends and demand. In order to be successful in these newer markets, Zara will need to invest heavily to duplicate its vertical integration system in these regions. Otherwise, it will be difficult for Zara to maintain its fast fashion mantra.

Duplicating their business model however creates a new set of problems; (1) difficulty communicating cohesive messages and strategies, (2) difficulty finding inexpensive labor (3) investment requirements will drain cash reserves. Resourcing inexpensive labor is a prominent issue. Zara manufactures 50% of its apparel in Portugal, and the rest in Asian, African, and South American countries. 2 Zara’s reliance on outside labor resources will increase if their vertical business model is duplicated in other regions. China has been a solution for many companies over the years, but as China moves up the value chain, it is no longer a viable solution. Countries like Vietnam and Cambodia are still cheaper solutions, but they don’t have comparable infrastructure to easily support large scale operations like Zara. 3 Zara will ultimately have to pay higher wages and heavily rely on their vertically integrated business model to minimize cost.

The competitive landscape is shifting for the retail industry as the price of cotton has risen steadily throughout 2011. Though the price of cotton has fallen in recent months from the 140 year high of $2.30 USD/pound in March of this year, it is still almost double last year’s price at this time (July 2011 reported $1.50 USD/pound). 4 The reason for the rising costs have been attributed to a drought in China, the number one world cotton producer, at the end of 2010 which delayed planting of the new cotton crop as well as unseasonal rains in India, the second largest world cotton producer. 5 With a global shortage of cotton, suppliers have been able to demand a premium.

Companies like Zara, who offer high fashion clothing at a low cost, are unable to pass on rising cotton costs to customers. A critical ingredient without substitute, the label on one pair of Zara trousers shows a 75% cotton composition. 6 Though Zara has not publically announced the impact of increased commodity costs on their profits, it is safe to assume that, all things being equal that Zara will have a difficult time maintaining their outstanding year-on-year profit growth in 2011. From 2009 to 2010 Zara experienced a 39% increase in earnings while sales increased only 14%. 7 Continued retail store expansion alone will likely be unable to maintain Zara’s profitability growth as the world sees more and more volatility in commodity prices like cotton. The challenge to Zara is to determine how much they can influence and stabilize their cotton supply limiting price volatility and potential shortages. Zara is also challenged to maintain their market position as a low cost, high fashion retailer while their variable costs, like cotton, increase.

The Path Forward
Economies everywhere are struggling through a slow recovery. As this struggle unfolds, it’s painfully obvious that no one country will recover without the recovery of neighboring economies. This common struggle illustrates like never before how interdependent many nations are to each other. Companies are waking up to the fact that the game has changed, making the current environment both a scary and exciting time to be at the helm of a company. Zara is not exempt from this worry. As a fashion leader in the western world, they must develop strategic tactics to maintain their Blue Ocean position.

The question is not whether Zara should expand into the rest of the world, but how Zara expands while maintaining their core strengths. This means that Zara should progress into new markets quickly, orderly, and with discipline, while concentrating on key regions first. The progression of fashion retailers into the developing world will require a strong understanding of the culture and heritage of the region they are entering. Zara needs to not only send teams of seasoned western designers but they need to cultivate fashion professionals in any country they plan to enter. Zara needs to find people with the same “passion for fashion” in the new regions they wish to enter; people with a strong sense of fashion but that are a product of the country they are entering. These people need to be folded into teams with Zara’s current designers to form regional cells that will allow Zara to produce new products that are cutting edge but are more in-line with local tastes. This will allow the stores they open in new markets to provide both the western fashion that they are famous for as well as more locally oriented fashions side by side in the same store. This could also have a reverse effect where some of the “local” fashions flow back into western markets.

Rising material and labor prices are a challenge that all manufactures are facing. Zara’s vertical strategy is well placed to take advantage of these inevitable price hikes. Everyday companies are waking up to the fact that consumers expect them to be socially responsible in ways that management never even could have envisioned. Society expects big business to contribute to its well being as much big business needs a healthy society to prosper. Zara should keep this in mind as it enters these new markets. Their success comes from being a fashion leader with an eye on low prices. They are not by any means driven by low prices and low prices alone. They have an opportunity to position themselves as a member of the community in whichever region of the world they plan to enter; pay workers a wage based on living standards of that particular country; attempt to buy cotton locally even if it’s a bit more expensive; provide local citizens with fashion and design education programs to develop talent and provide locals an opportunity for a career with Zara. This may slow profit growth initially but will pay dividends in the long run. Middle classes are springing up all across the developing world and a fashion company that sells to them and is also a socially responsible will be well placed in the future.

Amancio Ortega, Zara’s founder, views advertising as a distraction and that belief has added prestige to the Zara brand. But in this day and age, with Twitter, Facebook, Google+, and whatever social network they will invent tomorrow, a good social relationship with the global community can be more valuable than any amount of money spent on advertising. That is how Zara should present itself – a forward leaning fashion retailer that works in and with the local community in ways that are beneficial to society as well as to the company’s bottom line. Zara can do that while sticking to their small-batch, cutting edge fashion and the advertising will take care of itself.

The progression into these new markets will have to happen in an orderly manner. Parts of the developing world have the customer base in place and are ready while others still have a ways to go. Zara needs to be careful in its selection process and make sure they focus on areas of the world that have a customer base to support their stores. Zara must remember also that for true integration into a new society you cannot cookie cutter your current model into a new location. Instead Zara will need to take the time to learn about the places they are entering and form a strong plan for how to make a profit from being a good neighbor.

Sources
1 http://www.businessweek.com/globalbiz/content/aug2009/gb20090826_715608.htm
2 http://www.forbes.com/sites/andersonantunes/2011/08/17/zara-accused-of-alleged-slave-labor-in-brazil/
3 The Sunday Telegraph (United Kingdom): Cheap fashion is over, China warns West
4 http://www.wikinvest.com/stock/Gap_(GPS)
5 http://seekingalpha.com/article/278381-easing-cotton-prices-could-give-aeropostale-s-stock-a-big-bounce
6 http://en.cbf.net.au/Item/3668.aspx
7 Inditex 2010 Annual Report

Posted: 08|21|11 at 7:19 pm.
Filed under: Miscellaneous.
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