Zara Research Report

IntroductionThis report will focus on Zara, a firm engaged in international business. Firstly an environmental analysis will be conducted on the company’s business environment and its operations. The operations of a firm can be thought of as a value chain, split into value creation activities (Hill, 2012). This includes production, design, marketing and sales, material management, information systems, human resources and the firm’s infrastructure. The analysis will establish the competitive advantages of Zara, as well as their weaknesses, opportunities and threats. Advice will then be given on how Zara could implement a strategy to one of their value chain activities, with the aim of creating value for the firm. A firm can generate superior value by either reducing the cost structure of the business, or differentiating the product in a way that makes the consumers value it more and therefore be prepared to pay a higher price (Porter, 1980). The strategy recommended will involve either outsourcing to or re-shoring from an emerging economy, with the aim of achieving at least one of Porter’s two criteria.

A background on ZaraZara is a “trendy yet exclusive” international clothing retailer (Sulisetiasih, Junardy and Adam, 2013, p.24), offering designs to men, women and children. It is owned by the Inditex Group and was founded in 1975. The company opened its first store in 1975 in La Coruña, Spain. It then opened its first store abroad in Portugal in 1988 (Tokatli, 2014). This was the start of a global expansion that would see them open 748 stores in less than a decade (Tokatli, 2014). The Forbes Magazine (2014) ranks Zara as the 51st most valuable brand in the world, at a value of $10.1 billion. Zara earns revenue of $14.4 billion yearly (Forbes, 2014). As of 2013, the company produces 450 million items a year for its 1,770 stores in 86 countries (Berfield and Baigorri, 2013). Inditex reported a 7% increase in sales and a 5% increase in profit during the first 9 months of 2014 (Inditex, 2014). Zara accounts for around 65% of all products sold by Inditex; therefore this suggests Zara is currently experiencing strong growth (Tokatli, 2014). Growth in sales and revenue are shown in Figure 1 of the appendix. Environmental AnalysisIn order to conduct an environmental analysis on Zara, this report will first use a SWOT analysis, which looks at the company’s environment through its main strengths, weaknesses, opportunities and threats.

Strengths:The term core competence, a concept developed by Hamel and Prahalad (1994), refers to the abilities that a firm possesses that are not easily imitated by its competitors. These core competencies are Zara’s strengths and give them their competitive advantage. One of Zara’s main strengths is its vertically integrated operations system, which brings together designing, manufacturing, distributions and logistics (Marketline, 2014). The headquarters for this integrated system, in Arteixo, Spain, is the central base for a company built on the idea that speed and responsiveness are valued over cost (Berfield and Baigorri, 2013). The uniqueness of this vertically integrated system allows Zara

to maintain control of operations easier, and also distribute products globally in a short amount of time (Sulisetiasih, Junardy and Adam, 2013).

Zara is a leader in fast-fashion. The fast-fashion industry is an industry that entails the quick response considerations of retailers (Tokatli, 2008). Instead of creating their own designs, Zara’s employees seek out the most popular trends in haute couture fashion and mainstream consumers, and then create similar designs (Reinach, 2005). These designs are quickly turned into products and distributed to stores immediately, freeing the company from the “seasonal collection trap” (Reinach, 2005, p.48). Zara is able to develop and deliver a new product into stores in 3 weeks, which is notably shorter than its main competitors, such as Gap who take 9 months (Nelson, 2013). Being able to offer a wider variety of clothes more often allows Zara to obtain higher net margins on sales (Tokatli, 2008). Studies found that Zara earns 85% of the full price on its stock, compared to an industry average of 60-70% (Berfield and Baigorri, 2013).

Zara has developed its own complex information system, using cloud computing, which Zara employees use all over the world to communicate with headquarters (Nelson, 2013). This system not only allows managers to quickly relay data to designers about consumer preferences, but also allows staff in HQ to immediately work out what products are selling (Nelson, 2013). In addition to their complex IT infrastructure, Zara also has “trend spotters” based around the world searching for the latest trends (Tokatli, 2008). These two factors allow Zara to be more responsive than its competitors.

Weaknesses:An overdependence on the European market is one of Zara’s weaknesses. Inditex, Zara’s parent company, currently generates 69% of its revenues from Europe (Marketline, 2014). Europe’s GDP growth rate is forecast to be 1.2% this year and only 1.5% in 2015 (Marketline, 2014). This slow rate of growth has caused a decline in domestic demand, which is reducing Zara’s revenues within Europe (Marketline, 2014).

Zara only invests 0.3% of its revenue into marketing (Business Thoughts, 2011), choosing instead to invest extra revenues into opening new stores (Keller, 2012). As the company expands into markets where it does not have a strong brand image, a lack of marketing will become a weakness, especially if their competitors pursue strong marketing policies (Sulisetiasih, Junardy and Adam, 2013).

Recently, Zara’s centralised distribution and logistics centre has struggled to cope with the company’s rapid international expansion (Tokatli, 2008). With Zara pursuing a policy of outsourcing production- 46.9% of its suppliers are now in Asia, with 40.6% left in Europe (Inditex, 2009), operations are becoming difficult to control from one centralised centre.

Opportunities:Zara has the opportunity to expand its presence in emerging economies, particularly China. China has recently become the world’s second biggest consumer economy and accounts for 8% of global private consumption (Economist, 2014). Figure 3 shows that China’s total retail sales of consumer

goods have been consistently growing at a rate above 10% (Trading Economics, 2014). China is now Zara’s second biggest market in terms of the number of stores based there (Berfield and Baigorri, 2013). Expanding into emerging markets like China can offset declines in sales in Europe (Marketline, 2014).

Zara could seek to co-operate with new designers in emerging markets, in order to understand consumer preferences in these markets. Currently Zara has a dozen designers based in Shanghai and 250 in Arteixo (Economist, 2012). According to Jose Cervera (cited in Economist, 2012), China will soon overtake Europe in setting fashion trends.

Threats:The retail industry is highly competitive. Zara has to compete with not only well-established international companies, for example H&M and Gap, but also regional and local companies in the markets that they expand into (Marketline, 2014). Competition is particularly intense in Asia, where companies such as H&M have made full-scale entries into the region (Marketline, 2014).

Labour wages in Europe pose a threat to Zara, as they have been increasing at a rate of 1.2% in the past year (Marketline, 2014). With a significant proportion of Zara’s employees based in Europe (Inditex, 2011), rising labour wages could have a negative impact on the company’s profitability (Marketline, 2014).

A final threat is the risk of foreign exchange rate fluctuations. Shenkar and Luo (2008) argued that any company that has operations in more than one currency area would face foreign exchange risk and exposure. Zara is most at risk from variation in the Euro value. For example, a strong Euro would decrease the revenues of Zara (Marketline, 2014).

The Porter’s five forces model (Figure 3) can also be used to analyse the competitiveness of the Industry that Zara operates within. The model shows that the biggest risk to Zara is that rivalry within the industry is high (Sulisetiasih, Junardy and Adam, 2013). Other threats result from easy substitutability in the industry, due to a high number of retailers, and also a moderate level of consumer buying power (Sulisetiasih, Junardy and Adam, 2013). However, high barriers of entry into the industry, due to expensive start up costs, and a huge variety of suppliers available around the world works to Zara’s advantage in the industry (Sulisetiasih, Junardy and Adam, 2013).

From this SWOT analysis and Porter’s five forces model, a TOWS matrix can be constructed. A TOWS matrix is an advanced tool used for analysing strategies in international business. MindTools (n.d.) demonstrates that from this matrix, a company can decide on 4 types of strategies:

SO-Strategy – Using strengths to maximise opportunities. WO-Strategy – Minimise weaknesses by utilising opportunities. ST-Strategy- Using strengths to minimise threats. WT-Strategy- Minimising weaknesses and avoiding threats.

Figure 4 shows the TOWS matrix that has been constructed on Zara. From this TOWS matrix, the most suitable strategy for Zara can be chosen.

Choosing a strategyBefore recommending a suitable strategy, some key theories in IBM must be discussed. The strategy tripod, tying together industry, resource and institution based views of business strategy, can be used to help determine the best strategy for the company. The industry-based view results from conditions within an industry that determine firm performance (Porter, 1980). The resource-based view is derived from firm-specific differences that drive the firm’s strategy. Finally, the third view derives from institutions, defined as “the humanly devised constraints that structure human interaction” (North, 1990, p.3). This can be split into formal institutions, including laws and regulations, and informal institutions, including social norms and values (Peng and Meyer, 2011).

The dynamic capability theory can also be used, which suggests that firms cannot rely on existing resources, but must choose a strategy that develops ‘dynamic capabilities’, in order to sustain their competitive advantages (Shenkar and Luo, 2008). Finally, a strategy will be chosen that promotes the interests of the stakeholders in the firm. A stakeholder is “any group or individual who can affect or is affected by the achievement of the organisation’s objectives” (Freeman, 1984, p.46). There are many different types of stakeholders in a firm, including shareholders, managers, other employees, suppliers, customers, communities and governments (Peng and Meyer, 2011).

From the environmental analysis, it is clear that a suitable strategy for Zara to adopt would be an SO strategy – outsource some design operations to China. Outsourcing was defined by Barthelemy (2003) as the passing on of a value-chain activity to an outside supplier who will perform that operation on behalf of the firm. Outsourcing design operations will involve employing local Chinese designers to create new designs for Zara’s products in China.

Outsourcing design to China would be a sensible localization strategy for Zara. Hill (2012, p.437) defined a localization strategy as “focusing on increasing profitability by customising the firm’s goods so that they provide a good match to tastes and preferences in different national markets”. Using Chinese designers will enable Zara to differentiate its product according to local demands, thus increasing the value of the product in the Chinese market. This is an important industry-based strategy because “future consumer markets everywhere are going to look more Chinese” (Economist, 2014). Outsourcing design to China also provides an informal-institution based strategy. By using local designers, Zara will have a better understanding of the cultural and social preferences within the market, for example Chinese women prefer pastel coloured clothes to the stronger colours Europeans prefer (Economist, 2012).

Outsourcing design operations can help Zara to maintain its dynamic capabilities. It has been well documented that Zara values global responsiveness more than efficiency (Ferdows et al. 2004). According to the Economist (2014), “Firms that can flourish in China are positioning themselves for tomorrow”. With China starting to set the trends, Zara must focus on expanding its existing resources to be more responsive in China if they are to sustain their dynamic capabilities. Outsourcing design can also be viewed as a resource-based strategy, since Zara will be able to create a firm-specific difference by designing products that are better suited to Chinese tastes.

The main stakeholders to benefit are customers’ in China, who will have products available to them that are more accustomed to their tastes. However, becoming more successful in China will also benefit the shareholders of the company through increased profitability. The suggested strategy should avoid the problem of conflicting stakeholders objectives (Peng and Meyer, 2011), since the jobs of existing employees are not being replaced, but increased through outsourcing to keep up with the company’s global expansion.

Outsourcing will help to tackle the increasing pressure being put on Zara’s headquarters, resulting from the company’s expansion (Tokatli, 2008). 250 designers in Spain can no longer keep up with differing consumer preferences in the 86 countries that Zara operates in. Design operations branching out will relieve the pressure on designers in Zara’s headquarters and enable the firm to maintain its 3-week delivery process.

Outsourcing design operations to China could put the firm’s core competencies at risk. One of the main risks with outsourcing to China is the threat of intellectual property theft, for which China accounts for 50-80% of cases globally (Ovsey, 2014). However, Tungate (2005, p.50) argues that none of Zara’s designs are truly original; designers simply spot and copy popular trends. Therefore the design process does not run a large risk of intellectual property theft in China.

This strategy will decrease Zara’s dependence on the European market. By decreasing their dependence on Europe, the company can mitigate risks of rising labour wages in Europe and susceptibility to foreign exchange fluctuations in the Euro area. These are the two main reasons why re-shoring operations back from emerging economies is an unsuitable strategy.

Outsourcing design is a better alternative to offshoring operations, due to the risks that investing in China directly entails. Offshoring is the “moving of an activity to a location abroad” (Peng and Meyer, 2011, p.636). By outsourcing operations rather than offshoring themselves, Zara can mitigate some of the risks faced in China. One of the risks a firm faces in China is policy risk, defined by Henisz and Zelner (2010, p.90) as “the risk that a government will discriminatorily change laws, regulations or contracts governing an investment, in a way that will reduce financial returns.” In China, interpersonal relationships among managers serve as a substitute to formal institutions (Peng, Wang and Jiang, 2008). Due to the strong influence of informal institutions there, being a local firm gives you an advantage. However, China’s lack of formal institutions may give rise to the risk of transaction costs. Transactions costs are “the costs associated with economic transactions” (Peng and Meyer, 2011, p.39). Zara could face transaction costs if the designers they outsource to behave opportunistically and seek to cheat Zara in transactions. The risk of transaction costs becomes high without stable institutional frameworks (Peng and Meyer, 2011), and therefore Zara must ensure a high degree of trust with the chosen designers, before they outsource to them.

ImplementationZara should first transfer expertise to the outsourced designers when implementing this strategy. Zara must train these designers to produce designs in a short lead-time, and be able to adapt and produce designs with only the materials that are available to them (Sulisetiasih, Junardy and Adam, 2013). It would make sense initially to send some designers from Spain to China, in order to embed the organisational culture of Zara into the outsourced company and exert some control over the outsourced operation.

Once the designers have been trained, the next step for Zara is to use its advanced information system to help run quality checks on designs being produced in China. All designs produced in China should be sent back to Spain to be checked by existing designers in order to ensure they are of a high enough standard to enter production. Once the correct quality of products are being designed, and the risk of transaction costs have been eliminated, designs can be sent directly to production plants across Asia, in order to speed up the production process.

Concluding thoughtsUsing Porter’s (1980) criteria, it is clear that Zara outsourcing design operations to China would primarily focus on differentiating the product in a way that makes the consumers value it more. By creating designs that are suited to Chinese tastes, Zara can be more successful in a growing consumer market.

Design operations are the most suitable value-chain activity for Zara to outsource, due to the location-specific, resource-based and informal institution-based advantages of this strategy. This strategy will enable Zara to maintain their competitive advantages in local responsiveness and a fast supply chain, thus helping them to remain a leader in fast-fashion.

Word Count- 2750

Appendix

Figure 1: Sales and net revenue figures for Inditex 2009-2013 (Inditex, 2013)

Figure 2: Total Retail Sales of Consumer goods in China growth rate (Trading Economics, 2014)

HIGH

HIGHLOW

MODERATE

MODERATE

Figure 3: Porter’s five forces on Zara and Adam, 2013)

Figure 4: ZARA’s TOWS Matrix

Strengths Weaknesses

Unique vertically integrated operations system

High Dependence on European Market

Fast Changing Fashion Collections

Lack of Marketing

Advanced Information Systems

Price of product in emerging markets higher than rivals

Strong Brand Image Centralised distribution centre during global expansion

Opportunities SO Strategies WO StrategiesGrowing consumer markets in China and other emerging economies

Outsource some design to growing markets, to keep up with new trends.

Open new stores in emerging economies

Co-operation with new designers

Develop a ‘green’ and sustainable brand image.

Find ways to lower price in competitive markets

Rising environmental issues worldwide

Expand online business in key markets

Open new distribution centres in emerging economies

International RecognitionExpansion in the e-commerce marketThreats ST Strategies WT StrategiesIntense Competition Keep design, production

and delivery times quicker than competitors

Pursue a stronger marketing campaign

Labour conditions law-suits due to outsourced production

Outsource logistics to have more control over production processes.

Expand into other countries outside of Europe.

Rising Wages in EuropeForeign Exchange Fluctuations

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