Aalborg University BSc Economics and Business Administration 2012 October 24 Mini Project The ZARA Case Study in Economics and The Organisation of Economic Activity Contents Introduction 4 Describe th. From Transaction Costs Economics view, discuss if it makes sense to outsource work to “captive” suppliers. What would be the alternatives, and how do you evaluate them?
Aalborg University BSc Economics and Business Administration 2012 October 24 Mini Project The ZARA Case Study in Economics and The Organisation of Economic Activity Contents Introduction Describe the Value Chain of Inditex .5 From Agency Theory view, describe the incentives structure for the store managers 10 From Transaction Costs Economics view, discuss if it makes sense to outsource work to “captive” suppliers What would be the alternatives, and how you evaluate them? 12 In relation to the fashion sector in Europe, does Inditex posses a competitive advantage? Use the VRIO framework as the basis of your discussion .16 List of sources 19 Introduction Inditex is an eight-brand group of the world’s largest fashion retailers with its headquarters located in La Coruna, in Spain Founder and majority owner of the company is Amancio Ortega, famous Spanish entrepreneur Chairman and CEO of the company is Pablo Isla Alvarez de Tejera Inditex’s corporate culture is based on close communication between the customers and the employees. Today company has more than 100.000 employees worldwide The largest brand of Inditex is Zara, which runs three independent product lines for women, men and children where most of the accent is stressed on women’s garment Each of the lines is managed by separate team which consists of Diression de Tiendas (DTs) DT’s collaborate with commercials, country managers, HR managers and headquarters We can freely say that Zara is a pioneer in fast fashion industry The customer is at the heart of their unique business model, which includes design, production, distribution and sales through their extensive retail network The Zara case study is an interesting example on how one company can be successful on the market The dynamics of the company and its adapting ability show how important is the right thing regarding market’s needs Zara is an apparel chain that works differently from traditional retailers The main characteristic is the vertically integrated model Instead of relying fully on outside partners, the company manages all design, warehousing, distribution, and logistics itself The products are distributed in small batches Due to the stylish garment and affordable prices, consumers visit Zara’s stores very often Describe the Value Chain of Inditex Value Chain Inditex Primary Value Chain Activities Inbound Logistics Inditex Group is a vertically integrated group, which controls most of its supply chain About 50 % of its products are manufactured in Spain, 25% comes from Europe, and the remaining fraction is produced in locations in Asia and Africa After that, the whole production is received and warehoused in the logistics centers in Spain before being sent to the stores It does not matter where they have been produced, the main categorization is happening in Spain Materials and fabrics are kept in warehouses without exact colors or prints, due to be able to react quickly to market changes If it turns out that the demand is higher for the particular product, the company is able to react quickly and produce additional items with a particular design or color Sometimes, transportation of merchandise is by plane; for example: clothes, which are produced in Asia, have to be transported in logistics centres in Spain, there categorized and again transported to the Asia Furthermore, many countries have small warehouses where they keep extra or returned goods3 Operations Inditex country offices represent headquarters at the country level, supervising and coordinating the operations of the various Inditex brands Zara's headquarter in Spain consists of three spacious halls for each of these centers There designers work together with market specialists and planners for procurement and production Also, here designers can quickly check initial drafts with their colleagues and discuss about new styles Therefore, prototypes can be examined on site That kind of teams can work very efficiently; discuss about new fashion trends and take decisions within a few hours Market specialists are intermediaries between designers and store managers, who can Notes on Zara case Notes on Zara case Zara: managing stores for fast fashion Zara: managing stores for fast fashion quickly provide feedback to their colleagues in design and procurement What differs Zara from competitors is more capital intensive industry Each brand from Inditex Group has his own autonomy They can quickly react to market requirements, act in a flexible way by making changes without asking permission of third parties For example, Zara has power on operations, such as dying, labeling and packaging, all other manufacturing processes are made by Inditex employees Zara has three product lines: one for children, women and men All product lines go parallel with each other, but in an operational different way Procurement, sales, design and marketing operations exist for each of these lines; just they are different and separated Outbound Logistics At the beginning of each season, the whole merchandise is being distributed to the stores, in the quantities decided by the commercials However, when the production reaches the stores, managers are responsible for the order replenishments It is their responsibility to decide how many units of each item to order and to that, they are taking into consideration various data (forecasts of customer demand, how many of that product the store had and already sold and etc.) European stores are receiving their deliveries within 24 hours; in Asia and America receiving deliveries take 40 hours6 Usually deliveries are done by trucks or planes Each week, stores are receiving about 12,000 units However, sometimes it happens that they did not receive the whole order, because inventory at the logistics centers are limited Also, there were some improvements in time saving process In the beginning when the new merchandise was delivered, employees had to put tags on the products before they could reach store shelves, now tags are put by manufactory workers This improvement puts some value on faster delivery of the production to the customer Marketing& Sales Notes on Zara case Zara: managing stores for fast fashion Zara: managing stores for fast fashion Zara is using very unique marketing strategy Due to the fact, that they are not outsourcing their manufacturing, company can quickly respond to the customers demand in fashion trends Zara’s unique selling proposition is to produce the latest trend products within very short time (few weeks) and at affordable prices Moreover, products are on the store shelves no longer than one month People are more or less forced to buy the product, which they like due to the fear that next week it can be sold out Products, which are not sold out are afterwards discounted Zara has approximately eighteen percent of unsold merchandise, which is one of the lowest in the industry Comparing with other similar companies, Zara does not spend much money on promotion However, it does not mean that the company is doing nothing Zara thinks that the store windows and the content is the most necessary advertising for them Last, but not least interesting thing about Zara is that it owns the majority of its stores, but also does joint venturing and franchising in markets which are high risk and culturally distant Service Zara’s customers are young people, who are usually in a hurry; want to buy quickly something what they like without being bothered Due to this fact, sales associates are required to help, when they see that customers need help or ask directly for help Therefore, company is putting more effort in managing products than customers Also, it is very important to make sure that customers not wait in long queues Zara respects customers complain and try to respond as soon as possible Support Activities Procurement Zara sources fabric, other inputs and finished products from external suppliers who are usually in low cost source markets After certain designs are chosen for production, material is drawn from stock, cut, manufactured and delivered to company stores around the world Zara also owns 20 other factories for internal manufacturing that apply just in time.8 Inditex is purchasing raw materials through the company’s regional offices in the UK, China, Holland and other offices based in Europe, Asia and Australia.9 Technology Development Company puts the value on information transfer The whole Zara’s supply chain is connected through the constant flow of information Zara developed way how to transfer information easier than before They invested a lot in IT in the 1990’s before major phase of international expansion They developed quick response systems in the industry Company is using PDA (Personal Digital Assistance) in stores, which ensures a quick information flow within the company and creates value for the customers.10 Also, this system helps for the company to find out about new market trends as fast as possible and possibility to react quickly Human Resource Management All brands of Inditex Group have HR directors, who are supporting the stores on all HR issues, which are not linked to the operations and are organized by the geographical area HR department is well developed in this company Company puts a lot of emphasize on training of their employees, so usually sales associates before starting to work have at least one week training Zara’s product development teams are responsible for attending high fashion fairs and exhibitions to translate the latest trends of the season into their designs In this type of company hierarchy exists similar to one like the pyramid model Although thing that is interesting is that store managers have in their work autonomy The idea is that make them understand the value of freedom and to motivate them and give an opportunity to feel like the owners of their own store For the Zara Company’s CEO it is very important that there will not be disconnection between the store and headquarters CEO thinks that the feeling in the store can be transmitted and can make http://www.slideshare.net/binotrisha/zara-procurement-strategy Notes on Zara case 10 Notes on Zara case huge damage for the entire company, so it is important to make sure that employees are satisfied and motivated to work efficiently.11 Firm Infrastructure Zara developed business model where speed and decentralized decision making was essential This business practice, in turn, led to shorter lead times and introduction of more fashion styles The implementation of the information and communications technology helped augment the business processes at Zara At the heart of infrastructure is the IT technology The organizational structure supports IT technology The company’s CEO is Isla A.de T., the “head” of the company Next to the CEO there are headquarters, which are responsible for coordinating the brands, HR, IT, transportation and real estate Below the headquarters are “commercials”, which are organized into teams to analyze and interpret the sales figures for around 40 stores in a geographical area Next to “commercials” are HR directors who are supporting the stores on all HR issues that were not linked to operations and who are organized by geographical area Each Inditex brand has regional networks of DT, equivalent to regional managers and known internally as DTs, who are responsible for the operations and performance of 15 stores and have to evaluate how those stores are performing Country managers are also expected to be proactive in social issues Beside the central management above, each Inditex brand is managing independently, with its own network of stores, logistic centers and production facilities 12 11 12 Zara: managing stores for fast fashion Zara: managing stores for fast fashion From Agency Theory view, describe the incentives structure for the store managers In today’s world each company is trying to attract the best employees from the market that will give their best to achieve a company’s goals The most common problem that can occur is the possibility that your employees can have lack of motivation to contribute enough Where employer’s goals reach employees incentives? How the employer can motivate his employees in order to achieve best results? There are plenty of methods that people invented to monitor the work of others and constantly control the process It could be by direct supervision, cameras or it could be also by reports regarding financial performance Is it the best way to monitor the work of your employees all the time to insure yourself that the job is done? Many managers today decide that besides the salary, the workers should receive also a percentage of the sales or the whole salary could be depending on their contribution in the company Each individual has different way to measure his own contribution and the contribution of the people around him If we look at Zara’s store managers what will be their motive to work hard instead of shrinking? For Zara’s shareholders, CEO and etc, their goal is to increase the sales and profits Working hard raises the probability of making more sales, but the increased effort cost the store managers or salesperson from the other side In order to provide that effort they have to receive something for return which can be some kind of reward Zara puts a lot of emphasize on its employees Approximately 87% of them are at the stores and thanks to great communication they are interrelated with the company’s headquarters, commercials and DT’s Interesting thing is that people from bottom (sales associates) can be promoted to store managers, and we can see also this on other levels as well Let first start with the role of store managers At each store, three product lines are managed by three independent section managers, each with a team of sales people and cashiers Each manager is in charge for women’s, men’s and children’s section Woman’s manager is also the overall manager of the store Main characteristic that these managers have is autonomy They feel like entrepreneurs of the store as they have impact on orders for the store and this helps Zara to deal with different culture issues in various countries as they know local values This autonomy is in fact a bonding, as store managers can govern the store Zara’s philosophy isn’t just monitoring employees to perform well, but also to have them satisfied with their job So, sometimes we can see the situations when employees aren’t satisfied with the atmosphere and then they have the possibility to be transferred to another store (bonding) In our case we treated store managers as agents and commercials and DT’s as principals due to the fact that store managers should meet the principal’s goals To increase the productivity of the store and increase sales the store manager has to increase the productivity of the all employees working at the store To manage all this responsibilities, the manger has to develop specific skills that will meet the requirements Store managers receive competitive salary and a bonus based on how well they meet target sales In order to perform well they need also to coordinate sales associates As they are organized in teams there is an opportunity for shrinking, because of huge number of employees in an average store One of the sale manager’s task is to monitor sales associates and ensure work efficiency In one way we see that incentives are aligned because of monitoring which occurs at each level: sales associates are monitored by store managers, store managers by DT’s and commercial and DT’s and commercials by headquarters All their bonuses are affected by overall sales, so all of them should have an incentive to put more effort Another interesting factor that we found is the risk that store managers face when they are ordering replenishments They need to use their previous experience together with their ability to forecast new orders We see the risk due to the fact that store managers aren’t aware how many units will be sold, what will be the bestseller and how many units are available in warehouse For this reason Zara created incentive-intense payment model for store managers to motivate them to seek better results in their performance 10 From Transaction Costs Economics view, discuss if it makes sense to outsource work to “captive” suppliers What would be the alternatives, and how you evaluate them? Outsourcing is becoming more demanding nowadays The biggest international companies pay more attention to it in sense of trying to reduce their transaction costs Transaction costs consist of search costs, bargaining costs and policing/enforcement costs Firstly, we will assume that a company of the rang of Zara will not have financial problems concerning making a research about outsourcing elsewhere Also, the company has enough human resources which could be working on that field Secondly, in our case the most important part of the transaction costs of economics are the bargaining costs About 50 % of the production is manufactured in Spain (or in its proximity) Also countries in Asia, Europe and even Latin America contribute to the supply chain of this well known brand About 35 % of the production comes from Asia, 14 % from Europe and only % from America Raw materials come mainly from UK, Holland, China and some other destinations 13 Here we should underline that as far as the good comes from; it is more harder to control the supply process The small manufacturers in Spain provide the company with significant number of production Besides Zara’s own plants, these suppliers represent a good chance for the company due to their flexibility – they can change their production rapidly and of course, the smaller they are, the easier for control and price negotiation are they for the Zara They can easily depend on Zara, especially if they realize economies of scale and/or economies of scope Another example can be if Zara invested some capitals (for example equipment, new technologies, human resources and etc.) in these small manufacturers Third of all, policing and enforcement costs also could be significant, especially if the investment is based on know-how or patented products In our case, this is supposed to be resolved by a certain contract, which defines the exact rights and obligations of the both sides If Zara spoiled by some reason their partnership, these small manufacturers probably would face difficulties to find another big client for their production On that way, Zara could easily reduce its transaction costs by pressing the “captive” suppliers This situation will not seem very likely 13 Zara: Managing Stores for Fast Fashion – Harvard Business School 11 to occur in a big fabric which produces for many clients On the suppliers’ side, this also may be referred as a post-investment hold-up problem. Uncertainty is low because if any supplier does not want to work with Zara, the company could easily find another one We will assume that the small producers are required to buy or build expensive machines, which are suitable only for Zara In this case, we will have highly asset specificity that could reduce transaction costs Another reason for the importance of the small “captive” suppliers in Spain is that they will probably produce more expensive garment in comparison with low labour costs countries like China and India Due to the fact that Zara’s supply chain is short, the company can react quickly to the new trends Zara intentionally choose to produce mainly in Galicia and Northern Portugal because of the suppliers’ ability to accomplish fast changes However, that reflects on the transaction costs because producing in Europe is typically 15-20 % more expensive. 14 The relationship between Zara company and the “captive” suppliers in Spain can be also binded to other small suppliers elsewhere Small suppliers in China or India for example may have the same sensitiveness regarding price negotiation if they sell most of its production to Zara. We can easily see that 20 suppliers accounted for 70 % of all external purchases 15 The bigger suppliers have long term relationships with Inditex This allows Zara to minimize formal contractual commitments with them. Regarding the opportunities for outsourcing, perhaps in the future in order to remain competitive and control costs, Zara might have to move manufacturing mainly to China and India This can be a good advantage in view of transaction costs economics because the airfreight cost is about only % of the selling price The other advantage is the short time for delivery European stores received their deliveries within 24 hours and those in Asia and America received deliveries within 40 hours Also the average cost on a produced item is supposed to be lower in comparison with the factories in Spain.16 The cheaper labour cost will contribute to that This idea should be good considered even earlier, because the opportunity cost of not having more production in Asia because of fast changing orders, could be significant. 14 Zara: Fast Fashion – Harvard Business School Zara: Fast Fashion – Harvard Business School 16 Zara: Managing Stores for Fast Fashion – Harvard Business School 15 12 On the other hand, the company’s top management should think whether this will be enough to offset the lost speed ability regarding clothes production If Zara managed to find somehow low cost producing suppliers in Asia for example, which could be able to produce for the same time like the Spanish suppliers, the company will achieve great transaction costs reducement Of course, the precise answer of the question whether it makes sense to outsource depends mainly on account data and detailed further analysis Besides the clothes outsourcing, Zara made changes to outsource some of their day-to-day task in order to decrease operating expenses “Labour was the largest operating expense at the stores and any change to improve labour productivity would have significant profit implication.” One of the day to day task that bothers Isla and could decrease the labour operating expense is a process delivery What will be the difference for Zara to outsource their process delivery to a third-party logistics companies? At least twice per week, Zara stores receive early morning delivery that they have to move from the selling floor and remove the plastic covers from items and get ready for shelving The boxes and hangers held mixed products If we look at the situation in France they were encouraged to process at least 85 units per person. The question that arises here is how to improve the whole process Zara’s manager could consider to improve the labour productivity or to outsource process delivery to a third-party In both cases there will be positive and negative consequences of their action. Let’s first consider improving labour productivity and what will be the consequences of that action Until now as we see the whole work is done by the store employees and as we know it takes around 5% of their working time When we look at the negative aspects we see that they are doing the job slower that if Zara outsources the delivery process and the cost is higher than if they hire a third-party The positive aspect that we could have in that case is that store employees are familiar with the products and when they remove the plastic covers they can store them faster for shelving than a person who sees the product for first time. In order to reduce the time from 5% to 4% or less, store employees have to work under a lot of pressure and that may affect their later performance To make that choice managers should consider what they will receive and what they have to give away. The second solution that we have is to outsource process delivery to a third party If Zara decides to take that step they have to consider the transaction costs of that decision The first cost that Zara should pay is “search and informational cost” to determine that the required service is 13 available on the marker and compare the prices Outsourcing delivery process would save even more time and money, but they have to consider what could be the risk of doing that. When we look at transaction cost point of view we have to evaluate the asset specificity, the uncertainty and the frequency, in order to compare the cost of market transactions to the cost of internal transactions. In all business relations both parties have to sign a contract and assure that product specification is clearly defined in the contract. Here appears “bargaining costs” which requires coming to an acceptable agreement Zara’s requirements are the boxes to be moved from the selling floor and all the products to be stored and ready for shelving The logistic company will want to be aware of how often the deliveries take place, when the delivery takes place and how many units arrived, in order to prepare team for the job In our case the uncertainty has high level, because of the fact that stores receive at least twice per week orders but there is no guaranty for that Here comes the risk for Zara if there will be enough workers when the delivery takes place To ensure that, the logistic company may increase their demand and so the cost for Zara will increase The second factor that we have to consider is the possibility that every time when a delivery takes place there will be different team of workers so they won’t be aware of the situation there To remove the boxes from the selling floor and remove the plastic cover has lower asset specificity but at the same time to store the products by type it may require more time for people that see the product for the first time Finding the product and storing them for shelving requires the workers to be aware of the situation at the store That gives higher asset specificity In that case Zara may want the team to be always the same To insure that the logistic company will increase their demand. In order to evaluate the logistic company move, Zara needs only to analyze what moves their opponent can possibly make and evaluate all possible moves that they could make in answer to each possible countermove(when they describe the conditions in the contract). When the delivery will take place and etc.? These are elements of uncertainty/complexity that will increase the market transaction cost Of course if Zara conclude a contract for a long run or for all their stores in a specific country that may decrease the market cost In order to reach truce both parties will come up with their own requirements To decrease the market cost of outsourcing the delivery process Zara should predict all the moves that their opponent could make and come with an attractive offer 14 In relation to the fashion sector in Europe, does Inditex posses a competitive advantage? Use the VRIO framework as the basis of your discussion Competitive advantage is defined as superiority of an organization with regard to at least one product attribute over relevant competitors When a firm sustains profits that exceed the average of its industry, the firm is said to possess a competitive advantage over its rivals The goal of business strategy is to achieve a sustainable competitive advantage, which is very difficult task We will use the VRIO Framework to analyze the internal environment of the Inditex (Zara) which will help us to determine whether Zara has resources/capabilities to exploit it’s competitive potential “VRIO” is structured in a series of four questions: 1) Question of Value 2) Question of Rarity 3) Question of Imitability 4) Question of Organization Fashion industry is very competitive and subject to rapidly evolving fashion trends Based on the VRIO Framework and analysis of competitive advantage, we found that Inditex (Zara) has competitive advantage Inside a business model we can see a strong vertical integration and well organized supply chain, which combined with organizational structure gives to Zara flexibility to respond, adapt and deliver merchandise faster than its competitors Unlike their competitors such as H&M, Mango, United Colors of Benetton in Europe, Zara has disintegrated decision-making model And above all, the price of merchandise is affordable Now we will analyze each question in detail regarding VRIO Framework 1) Value – does a resource enable a firm to exploit an environmental opportunity and/ or neutralize an environmental treat? We see Inditex rather as a combination of resources, so the most valuable resource we would put is the vertical integration Instead of relying on third parties, the company manages all design, warehousing, distribution and logistics function itself Doing that they are more flexible and faster than competitors and we know what these two words mean in apparel industry Along with the vertical integration which also reduces operating costs it has excellent conceived organizational structure and values that all employees must respect The reward is great autonomy that store managers have Some skeptic persons could ask whether this value could be used in future? Our answer is probably yes, as Zara carefully follows changes in consumer tastes and due to flexibility and speed it can adapt Second justification could be that it follows world trends and it might outsource more from Asian markets to reduce its costs 2) Rareness – how many competing firms already posses particular valuable resources and capabilities? If we analyze competitors we’ll see that most of them outsource most of the 15 production, while focusing on distribution and retailing The reason is that the industry is more labor-intensive Inditex does just the opposite It puts more emphasize on capital-intensive industry.17 Difference could be easily seen in figures: “Zara is able to produce new items and deliver them to its stores in less than three weeks rather than the average six months needed for luxury brands and in terms of production in a typical season it produces about 11000 different items while competitors would produce typically between 2000 and 4000.” 18 So we see that the resource is rare 3) Imitability – firms without a resource or capabilities face a costly disadvantage in obtaining it compared to firms that already posses it? Nowadays almost everything is imitable The question is how long it takes to imitate In the case of Inditex we freely assume that if competitors were to copy Zara business model, they could, but only in a long run It would take a few years to establish vertical integration model with that kind of supply chain and even more to create organizational structure (culture) that Zara has We should also take into consideration enormous costs that those firms would incur in order to copy the model, which are often impossible for firms to incur Although if this is supposed to happen, we think that in meanwhile Zara would probably progress more in other segments, because as we saw they make small changes very often To cite the Inditex’s founder Amancio Ortega when he talked to Pablo Isla who is CEO: “Once a month, come here thinking that we are near bankruptcy You will find a lot of things to change.” 4) Organization – is a firm organized to exploit the full competitive potential of its resources and capabilities? We can see that it is If we look at the annual reports we can see that they are constantly increasing sales and profits Merit for this goes to top management, but also to every individual engaged in every process of Inditex We shouldn’t forget that section managers have autonomy and that they together with the DT’s, HR managers and commercials contribute to success Here lies their strength Possibility of coordinating all those people despite the fact, that they have some kind of autonomy in decision-making process.”19 The VRIO framework Although Inditex combines it also with labor – intensive industry ( doing that they are more flexible and faster in producing garment ) 18 Zara: Managing Stores for Fast Fashion – Harvard Business School 19 Zara: Managing Stores for Fast Fashion – Harvard Business School 16 17 Is a resource or capability … Valuable? Rare? Costly imitate? to Exploited by Competitive the Economic implications Performance Competitive Below organization? No - - No disadvantage Normal Yes Yes No Yes - Competitive ↑ No ↓ parity Temporary Above competitive normal(at advantage least in the short run) Yes20 Yes Yes Yes Normal Sustained Above competitive normal advantage 20 Bold text refers to Inditex’s ( Zara’s ) case 17 List of sources Zara: Managing Stores for Fast Fashion – Harvard Business School Notes on Zara case Inditex Group: Annual report 2011 The Economist:Inditex - Fashion Forward The Economist: Global Streach - When will Zara hit its limits? The Economist: Good Darning Vietnam The Forbes: The Strategic Retail Genius Behind Zara The Forbes: The Future of Fashion Retailing - The Zara Approach http://www.gallaugher.com/Zara%20Case.pdf http://hbswk.hbs.edu/archive/4652.html http://researchingsustainability.files.wordpress.com/2012/01/zara-harvard-case.pdf http://www.slideshare.net/binotrisha/zara-procurement-strategy 18