612-006-1 UCLAAnderson case stuoy School of Management Create 19, 2601 ZARA: Staying Fast and Fresh In early 2011, despite a successful decade of continued growth, fashion retailer Zara's CFO Miguel Diaz was anything but complacent. When asked about the future, Diaz responded: Challenges abound. At the pace stores are being added in the rest of the world, the inevitable question is whether we should open our first major distribution center outside Spain. Another concern is that the prices of raw materials and labor are nat going down, in part because the cost structure in Asia is changing, ‘The old textile model in which each year better garments were produced at lower costs will not hold on forever, and we have to remain alert to these changes. Zara, the flagship brand of the Spanish retail conglomerate Inditex, was one of the leading retailers of fastfashion, churning out frequent in-season assortment changes of knockofis of popular runway styles and trendy fashions. The company had received a lot of attention for its centralized distribution model. In the past 10 years, Inditex and more specifically Zara had been studied by MBA students, the world over, to understand its success in distribution and supply chain efficiency, Numerous cases had been written by academics to better understand Zara's operations, marketing, information systems, and overall strategy, but the same authors had always questioned Zara's long-term sustainability. (See Exhibit 4 for a brief survey of previous cases.) Nevertheless, Zara's net sales reached €8,088 million in 2010, representing an increase of 14% over the previous year and right in line with the average growth it had shown over the last decade. (See Exhibit 2 for a graphical representation of Zara's growth and significant events.) Inditex In 2010, Inditex founder Amancio Ortega Gaona was considered by Forbes Magazine to be the 9th richest man in the world, but his life did not begin that way. Ortega began his career in 1963 as a clothing manufacturer in A Coruiia, Spain making garments for wholesalers. The way the story goes, in 1975, after a customer cancelled a large order, Ortega decided to open his own store as an outlet for unsold products, It was to be called Zorba, following the popular film featuring Anthony Quinn, but that name had already been taken by a nearby store. In a quick display of his decision making, Ortega reused the billboard letters and came up with the name Zara, Through his own store, Ortega leamed firsthand what customers wanted and realized that Professor Felipe Caro prepared this case as the basis for Gass discussion. The content doos nat engage the ‘esponsibilily ofthe Inditex Group. The case is not intonded to serve as primary source of dala, endorsement, or a description of adequate/inadequate managerial practice. Special tanks to Katherine Heifet and Paige Hoslor who helped in the wring process. This project was supported by the Easton Technology Leadership Program. Copyright © 2011 by UCLA Anderson School of Management, All rights reserved. No part of this publication may be copied, stored, transmitted, reproduced or distnbuted in any form or medium whatsoever without the permission of the copyright owner. rnd eh OkaNdUEA Nathan alow Dove cssetoriaring 2 Einianses apenas612-006-1 Zara: Staying Fast and Fresh UCLA Anderson School of Management it often did not match the styles that wholesalers were ordering. He then made it a rule to have fone hand touching the factory and the other touching the store. The importance of handling large amounts of information also became evident, and in 1976 he purchased his first computer. In the 1980s, Ortega’s interest in technology led him to meet Jose Maria Castellano, a professor at the local university who had experience with information systems, sales and finance. In 1985, the Inditex Group was established as the owner of Zara and Castellano joined ‘as Deputy Chairman, Castellano helped to drive growth in the organization and to develop technological support for the vertically integrated business model that Ortega had envisioned. ‘The philosophy of end-to-end control guided local expansion in the 1980s and worldwide expansion in the decades that followed. In parallel with the international expansion, Inditex also expanded its brand concepts. In 1991, Inditex jaunched Pull & Bear, which had a larger selection of everyday basics, that is, garments with less fashion content end more competitive prices. The same year, Inditex acquired 65% of Massimo Dutti, a brand originally targeted only to men, offering a more sophisticated lock with great attention to fit and fabric quality. Inditex later took full ownership of the brand and diversified its assortment to include women's and children’s wear. The concept of Bershka was introduced in 1998, aimed at avant-garde female shoppers in their teens, A year later, Inditex acquired Stradivarius, which complemented its portfolio of trendy garments for women in their mid twenties. Outside of common functions such as human resources, information systems and real estate, and a shared focus on cutting-edge designs at affordable prices, each brand operated independently, When Ortega decided to step down in 1997, Castellano took over as Inditex’s CEO. Castellano's ongoing vision for the company led Inditex to an Initial Public Offering (|PO) on May 23, 2001. Ortega agreed to sell 26% of his stake in the company to the public. The IPO was not intended to generate cash for the company as the revenues from the sale went back to Ortega. Instead, it was intended to stabilize management and solidify the company's leading retail position, The IPO was oversubscribed by 22%, signaling that the shares were undervalued. Simultaneously, Inditex agreed to distribute 4.3 millon shares to employees through an Employee Stock Patticipation Pian. Ortega maintained just over 60% of the ‘company’s equity. In 2005, Castellano resigned 2s CEO of Inditex. With the help of an executive search firm, the Board of Directors proposed the appointment of Pablo Ista as the new CEO, Isla had achieved great success as a state lawyer chairing the Board of Directors of the Altadis Group and serving as general counsel to Banco Popular. In a press release from Inditex, the company cited its choice of Isle as "a step forward in the design and reorganization of the management team of Inditex.” Isla oversaw Inditex’s continued growth while emphasizing store execution and overhauling internal processes. His frequent visits to the stores not only demonstrated his commitment to Inditex’s “bottom up" structure but also allowed him to recognize opportunities for improvement.612-006-1 UCLA Anderson Schoo] of Management Zara: Staying Fast and Feesh In 2008, an economic crisis hit Spain hard. Much like in the U.S., the crisis was generated by long-term loans, but in addition Spain had a large trade defici These factors drove the unemployment rate above 20% in the years that followed. The developed world entered into a recession that depressed consumer confidence and affected most market sectors, in particular the retail industry. (See Exhibit 3 for stock prices for Zara and its direct competitors.) Despite the crisis, Inditex closed the decade in 2010 with a Compound Annual Growth Rate (CAGR) of 37% (see Exhibit 4), In terms of locations, Inditex had grown from 1,080 stores in 33 countries in 2000 to about 5,000 stores in almost 80 countries ten years later. The number of employees quadrupled over the same period and three more brands were added, Launched in 2001, Oysho offered stylish lingerie and intimate apparel. Zara Home was introduced in 2003, expanding Zara's concept to home decor. Uterque opened in 2008 selling high-end accessories and a fashionable selection of leather garments. As for Zara, 2010 crowned a decade during which it consolidated its position as a leading global brand in the apparel market. Competitive Landscape Among specialty apparel retailers worldwide, Inditex took the lead in annual revenue (see Exhibit §). Its three most relevant competitors were Gap Inc., H&M and more recently Fast Retailing. The Gap Based in San Francisco, CA and originally founded to sell Lev's jeans, The Gap saw great success through the 1980s and 1990s and grew with an expansion of concept stores, including Banana Republic, Old Navy, Gap Outlet and Gap Inc. Direct, the online division. The Gap was known for its unpretentious basics, which included jeans, T-shirts, khakis and regular work clothes. It operated a “buying” model for the manufacturing and production of its garments, and orders to manufacturers in international locations had to be placed 9 months before the season began. Products were manufactured in large quantities and extensive promotions were used to stimulate demand so a 30% markdown off the full price was very common. Led by retail innovator Mickey Drexler, The Gap opened its frst international store in the U.K. and reached sales of $18 in 1987. Though global expansion continued, it was hindered by a challenging cost structure and adaptations of size and color for different markets. After the departure of Drexler, the consumer trend to more individualized clothing and a failed attempt to make the brand more fashion forward, The Gap saw its revenues decline from a peak of $16.48 in 2004 to $14.28 in 2009. In 2010, The Gap had fully-owned stores in six countries and franchises in another 22 international locations. Hennes & Mauritz H&M was founded in 1947 in Sweden and saw good success as a specialty apparel retailer. H&M was seen as Inditex’s closest retail competitor on product offerings in specialty apparel, though it operated only one concept with its own name. Although these stores carried a variety of private label brands appealing to different customer segments, H&M delivered large marketplace-like stores with low prices and high variety refreshed dally, Using about 100 in-612-006-1 Zara: Staying Fast and Fresh UCLA Anderson School of Management house designers, H&M designed and purchased its product mix from 700 independent suppliers in Europe and Asia. H&M also depended on a large network of distribution centers located in ‘each country of operation. H&M expanded rapidly in the new century, with revenue growth up to 127 million Swedish kronor in 2010. Its goal was to achieve 10-15% growth in the number of stores each year. In 1998, H&M launched its own online shopping portal in Sweden and then followed in Norway, Denmark, Finland, the Netherlands, Germany and Austria, It was not until September 2010 that H&M launched its online shopping portal in the UK, making it the eighth country with an H&M e-commerce platform, Fast Retailing Despite revenues equal to only 56% of Inditex’s in 2010, Uniqlo and its corporate owner Fast Relailing managed to grow rapidly over the turn of the century. In that time period, CEO Tadashi Yanai doubled the revenues of Unigio and had a big vision for the company going forward, His goal was to expand the company tenfold within ten years to achieve sales of ¥5 trilion by the year 2020. Although Fast Retailing was originally founded in 1963 as a men’s apparel retailer, the first Uniglo store was not opened until 1984. Uniqlo offered inexpensive basic clothes, providing a broad array of colors to its customers. Fast Retailing had pushed its way into foreign markets determined to gain market-share. In 2009, the company acquired Theory, a New York based apparel design company with a large share of the workplace attire market, providing tailored suits in a high quality stretch textile to young professionals around the world. This expansion of concept further exemplified Fast Retalling’s quest to get a foothold in the global apparel market. Benetton ‘The Benetton Group was founded in Italy in 1965 and had become a world leader in providing knitwear by the early 1980s, supplying more than 1,900 shops with its sweaters, shirts and jeans, Benetton was one of the first major retailers credited with utlizing deferred differentiation in its production of clothing, a strategy that delayed the process of dyeing until afier yarn and fabrics were assembled into garments. This strategy gave Benetton a competitive edge, but eventually other retailers followed and deferred differentiation became mainstream. Benetton's operations were highly decentralized and most of its retail stores were owned and operated locally as franchises, limiting its ability to track demand and make changes to product assortment in a timely manner. The Benetton Group was considered a major competitor in this market in the 1980s and 1990s, but it struggled to keep up later on. In fact, Benetton’s sales increased less than 2% to €2.05 billion over the period from 2000 ~ 2010." Zara's Continuous Business Cycle Zara's business depended on the close relationship between manufacturing and retailing. By keeping a pulse on the desires of the customer at retail locations, Zara could quickly manufacture and produce fast fashions and feed them back to the customer, creating a virtuous circle.612-006-1 UCLA Anderson Schoo! of Management Zara: Staying Fast and Fresh Customer Feedback and Fashion Trends ‘The continuous business cycle began with the customer at the store level, and tight ‘communication between store managers and headquarters was vital. Zara designers were constantly listening to advice and comments from store managers who interacted with customers on a daily basis. Market specialists at Zara headquarters, internally known as Commercials, understood the importance of developing deep personal relationships with the store managers for their regions. During their regular contact, the store managers offered suggestions, advice and criticisms on the merchandise, opinions that had been developed through retail experiences with customers, The Commercial then spoke to the designer for that division, for example Women's knitwear, to share the latest market information. After a new design was created and approved, it went to the procurement and production planners to be manufactured ‘A Commercial did not have to go very far to talk to the procurement and production planners. Emphasizing the importance of the communication circle, the layout of Zara's headquarters consisted of large open areas for each section, Women, Men and Children, so that designers, Commercials and procurement and production planners could work next to one another ‘Communal tables in the area facilitated last-minute meetings. The functional design of the work environment allowed designers to check sketches with co-workers, Commercials to relay feedback from the stores and procurement and production specialists to make initial cost estimates for manufacturing Each year designers at Zara came up with approximately 24,000 new products, but only one third were actually produced. This stil represented 3-4 times more products than a traditional retailer. A collaborative atmosphere reigned in the design center, and designs were developed from a variety of sources of inspiration, including magazines, catwalks and trend spotters. Large traditional retailers had a nearly 40-week pipeline, meaning buyers had to make calculated guesses of style developments in advance. At Zara, rapid production capabilities and a production lead-time of only a few weeks allowed designs to be based on observable market trends, Zara purchased and designed about one third of its offerings before the season started and left the remaining two thirds to be created continuously based on style trends, which gave Zara valuable flexibility in its product array. Procurement and Production Inditex had a stake in every link of the supply chain beginning with the fabric, which was purchased through offices located in Barcelona and Hong Kong. The fabric was then sold to in- house and external manufacturers. Almost half of it was carried without dye as coloring was often postponed until later stages of production. Roughly 50% of Zara's products were manufactured in factories located in Portugal, Morocco or adjacent to its headquarters in A Coruna, Most of these factories were fully owned by Inditex, and work was organized according to just-in-time (JIT) principles as a result of collaborative projects with Toyota (Japan) in the 1990s. The other 50% of production came from outside suppliers, with 30% located in eastern European countries like Turkey, Bulgaria and Romania, The remaining 70% were overseas612-006-1 Zara: Staying Fast and Fresh UCLA Anderson School of Management ‘suppliers that had a 15-20% production cost advantage and usually procured Zara's basics. In general, basics were ordered in larger quantities compared to more trendy items that were produced in small batches. Before making any decision regarding procurement or production, Zara made an assessment of speed, expertise, cost-effectiveness and availability. If the company could not produce an item at the price it wanted, Zara would look to outside manufacturers. For the products manufactured in-house, the next step in the process was cutting the fabric. Operators used CAD systems to check fit and sizing of the cutting pattern in order to minimize waste. After a first cut and approval from the machine operator, several layers of fabric were cut simultaneously following the same pattern. From here, the fabric was sent to a large network of sewing workshops. Zara had developed close relationships with more than 500 sewing subcontractors in the A Corufa vicinity. By outsourcing the labor-intensive work, Zara allowed its own facilities to remain focused and flexible. Finished products were sent back to the factories for ironing and quality control, and then they continued onto the distribution center at the headquarters. An aerial monorail system connected a dozen factories to the distribution center so that hanging and folded garments could be rapidly transferred between divisions. Distribution and Warehousing The distribution process began at the store level, which had the best understanding of what customers wanted. From a distribution standpoint, there were two key pieces of information that were gathered at each Zara store. The first piece of information was the point-of-sale data that was captured daily and transmitted directly to Zara's headquarters in Spain. The second piece of information was the bi-weekly order placed by each store. On the day the order had to be laced, the product assortment for the next shipment, known as “the offer, was downloaded conto a handheld device. The assortment included articles that were already available at the store as well as new products that were being introduced. Next, a store associate walked through the store to check the inventory levels and entered specific quantity requests for each article, including color and sizes. Though the product assortment was common to all stores, there could be significant differences in demand that sometimes made a product more successful in certain stores than in others, The store employees were the most aware of these differences and that was reflected in the order quantity that they requested for each article. Zara had a fixed schedule to place orders and the store manager was responsible for transmitting the information electronically by the cutoff time. The disparity in inventory levels and demand patterns among stores introduced enormous variability in the shipment requests. All of these orders arrived at the headquarters and the distribution team then decided how much to ship to each store, The chosen allocation was transmitted to the warehouse control system, which effectively implemented the physical picking, sorting, packing and freight loading operations. (See Exhibit 6 for a location of Zara's warehouses.) The distribution centers operated far below capacity on average to ensure that they could respond fo demand almost immediately. They were divided into two distribution areas, one for the hanging clothes and one for the folded clothes. Picking was done in a wave picking fashion. That is, the same article was picked at once for all of the different stores. The second step was sorting so that different items612-006-1 UCLA Anderson School of Management Zara: Staying Fast and Fresh going to the same store were put together in the same shipment. For the hanging clothes, each store had a dedicated rail with a red tag indicating the name of the destination so the warehouse ‘employee knew where to hang each item. For the folded garments, a state-of-the-art sorter was used to place each item in the appropriate shipment. Shipments were made by truck, or for more remote locations by plane, so that the items reached the destination store within 48-72 hours. In the case of ground transportation, the trucks were loaded directly at the docks attached to the warehouse. In the case of stores reached by plane, an air-cargo container was filled at the warehouse and then transported to the airport and loaded onto the aircraft, Zara divided its worldwide network in four geographical areas, and every day it shipped specifically to one particular area. When the shipment finally arrived at the store, the items were unloaded and the store associates checked the products and quantities that arrived, which could have been different from what they originally ordered depending on the allocation performed by the distribution team. Most of the items were placed immediately on display. Retailing and Closing the Circle At the retail level, special locations were chosen after extensive market research focusing on prestigious locations with a voluminous flow of upscale shoppers. The location of the stores was crucial to the success of the business. Because Zara spent litle money on advertising, approximately 10% of competitors’ expenditure, brand recognition was dependent upon store Visibility * Zara favored landmark buildings, even if they required significant remodeling efforts (see Exhibit 7 for two before-and-after examples). Zara worked hard to create a special store experience, The layout and decor of the stores was managed at headquarters by a designated location team that oversaw the remodel and fixtures in the new openings. The store interior and exterior had to be attractive and give a sense of well being to the customer. The shop floor was designed to be spacious and provide a sense of luxury. The density of a typical Zara store was 28 units of inventory per square meter while traditional retailers usually had between 32 and 43 units/n The products quickly changed at Zara stores as new items arrived twice a week. Store managers were incentivized to get slower moving inventory off the shelves. Offering fashion forward pieces in small quantities created a sense of urgency among customers. In fact, when shoppers saw something they liked there was an impulse to buy because the item would likely not be there a week later. Promotions were rare but even so the regular shopper visited Zara stores on a monthly basis. in contrast, the same shopper on average would visit a comparable traditional retailer only @ few times a year. Some Zara customers even knew which day inventory arrived and shopped accordingly. Even taking into account clearance sales, the average Zara item sold with haif the markdown of a comparable traditional retaler. In terms of personnel, Zara strived to retain the best store associates. In order to do so, Zara developed a retail sales structure that gave store associates autonomy over their own product lines. In fact, a typical Zara store would have three store managers, one for Zara Women, one for Zara Men and one for Zara Kids. Under Zara Women, for example, each product line612-006-1 ‘Zara Staying Fas and Fresh UCLA Anderson School of Management (knitwear, suiting, etc.) would have its own product manager. This organizational design meant that almost every store associate had a unique set of products for which they were specifically responsible. Ortega believed that autonomy and responsibilty built company loyalty and dedication. Zara also offered an incentive program that promoted collaboration within each store, as employees were compensated based on salary and overall store sales. Regardless of the rank, everyone at Zara had to have some store experience and promotion from within was strongly encouraged. In an industry with high turnover, employee morale at Zara remained very positive International Expansion Zara more than doubled in size over the period from the early 2000s, when it first became known worldwide, to 2010. The majority of that expansion took place outside of Spain. In fact, domestic stores accounted for 22% of total sales in 2010, compared to 37.5% in 2002. Zara considered expansion into a new country after several analyses. First, it did a typical macroeconomic study including the evaluation of tariffs, taxes, legal costs, the labor market and property prices. Second, it did a microeconomic analysis with sector specific demand, channels and available store locations. Finally, headquarters looked at the concentration of key competitors and attempted to understand any region-specific barriers to entry, including political and legal factors and the ability of those factors to resist or inhibit entry. Different from most retailers, Zara determined its product pricing based on market pricing rather than cost forecasting. Instead of using @ markup rule, Zara determined what prices the market could handle and then determined product prices accordingly. Such a strategy meant that Zara was positioned differently in each country. In Spain, Zara clothes were seen as inexpensive and meant to be worn only a few times, whereas in the Americas Zara products were positioned to be higher end, leveraging the perception attributed to European designs, After pricing and positioning were determined, Zara decided how to enter the market operationally, The three options for market entry were wholly owned stores, joint ventures and franchises, Wholly owned stores were common when a country had high growth prospects and low business risk. Joint ventures were usually reserved for larger, more important markets where entry could be challenging. A franchise operation was the mast typical strategy for small risky countries with significant cultural barriers. The franchise agreement was usually designed as a 5-year contract with feas of 5-10% of sales, but Zara always maintained the right to either buy out the franchisee or open wholly owned stores during that contract period. This arrangement allowed Zara to test new countries without bearing significant risk. Only 3% of all Zara stores were franchises in 1999 but by 2010 that number grew to 10%. From 2007-2010, Zara focused its expansion on Asia. In fact, Inditex's growth rate in Asia during that period was double that of the rest of the world, This push was furthered by the economic crisis that hit western countries harder, but that only served as confirmation for a strategic choice that had been made prior to the economic downtum. Zara first entered China in 2006, and only four years later it had opened 71 stores and proven its concept. In contrast, Zara entered the United States in 1987, and by 2010 it had only opened 49 stores. At this rate of612-006-1 UCLA Anderson School of Management Zara: Staying Fast and Fresh growth, China was on track to take over as having Zara’s second largest presence outside of Spain, trailing behind only Italy with 64 stores and France with 113 stores. Unlike shipments to Italy and France, however, shipments to Zara's stores in China travelled over 5,000 miles, In 2010, CEO Pablo Ista announced that India would be one of Inditex’s next top priorities. This statement followed an agreement signed between Inditex and the conglomerate Tata Group for @ 50/60 joint venture to introduce Zara stores in India. (See Exhibit 8 for projected store ‘openings in 2010.) Zara's global expansion did have its share of chellenges, particularly with operations and store execution. These challenges motivated several initiatives that reflected the ‘company’s dynamism. Internal Processes Overhaul One challenge that surfaced was related to the incentive structure and its connection to the inventory allocation process. Given that compensation was based uniquely on total sales, there was an impression that store associates would frequently request quantities exceeding their true weekly needs, particularly when they anticipated that the inventory level of a top-selling article was scarce at the warehouse. Without formal rules for allocating the inventory, the distribution team was constantly struggling to Keep store managers and headquarters happy while simultaneously helping to manage the allocation process. Availability of sizes was another key factor in the inventory allocation process. Zara put merchandise out when the set of available sizes was complete enough. Zara believed that if there was not enough size availability — in particular, the most popular sizes ~ it could damage brand perception. Therefore it was important to have a complete enough set of sizes available to the customer at all times. When a siore associate realized that there were not enough sizes available for a given product, all remaining inventory of that product was moved from the display area to the backroom, which ‘meant that the product was removed from customers’ sight. Therefore, the inventory allocation process had to ensure that a complete enough set of producs were in the store at evary point in time, making it a complicated rationing problem. Moreover, Zara had to solve this problem for thousands of products in just a few hours. Zara's leadership viewed the inventory allocation process as an opportunity for improvement. The legacy process of using a few inventory specialists to determine order quantity and size distribution was still functional but there was the feeling that it could be leaving money on the table as the chain expanded beyond its first 1,000 stores. In 2005, Zara teamed up with academics in operations management to develop a new allocation process based on formal forecasting and optimization models, The forecast model used historical sales data and the input of store managers, which was then fed into an optimization model that maximized sales across the entire store network while incorporating inventory availabilty and the display policy regarding sizes, The use of analytical models, also known as Operations Research, focused on finding the global optimum for the chain rather than many local optima for individual stores and helped to create a scalable process with consistent allocation rules. Zara was a company that favored vision and judgment for decision-making. Although the use of quantitative tools such as spreadsheets was common, at the time the company had no prior612-006-1 Zara: Staying Fast and Fresh UCLA Andecson School of Management experience using analytical methods. Consequently, the new model-based allocation process was met with natural resistance from the distribution team, The value of the project was severely questioned and threatened to halt on several occasions. Fortunately, the project had the support of CFO Miguel Diaz and it found an intemal champion in José Antonio Ramos, who believed in the mode''s potential from the outset and voluntarily took the lead. Ramos was the main counterpart for the academics involved and was able to recruit key employees in the Information Technology (IT) department to devote time to the project above and beyond their regular duties ° Overcoming the initial concerns required long sessions and a substantial communication effort, but the tipping point came when the mechanics of the model were understood and the distribution team realized that the new process would shift its responsibilities from repetitive data enty towards exception handling, scenario analysis and process improvement. The breakthrough came in 2007 when a controlled field test was run to ensure that the model accurately forecasted and optimized inventory needs. The live pilot experiment was a success and showed that the new process was able to allocate inventory where it was most needed and was able to ship specific sizes only where it was likely to generate sales. Overall, sales increased by approximately 3-4%. This led to the worldwide rollout of the new process. The estimated realized financial impact was about $233 million and $353 million in additional revenues for 2007 and 2008, respectively. ‘The success of the inventory allocation model also ignited interest in other applications of analytical methods to support its operations. In the words of Miguel Diaz, "it showed that Operations Research can significantly contribute to Zara’s strategic goal of improving the scalability of its operations in order to support its continued growth.” In 2008, Zara developed another mode! to optimize markdowns during clearance sales. In the past, markdowns were determined through @ manual process that depended largely an the experience of each country manager. Again, there was an issue of scalability, but most importantly, country managers had tendency to focus on liquidating stock rather than maximizing revenues, which stemmed from the pressure to open up space for the incoming season. An optimization model proved effective in balancing the forces at play. It gave guidelines on when to markdown aggressively and when itwas better to wait, ‘The markdown project had its own challenges. For one thing, it required country managers to become comfortable with a sales forecast. The average forecast error was less than 24%, which ‘compared favorably to other markdown applications, but this number was still unsettling to several who thought, "How can we trust the model if the forecast is wrong one fourth of the time?" As before, communication proved to be essential and in this case the tipping point came at the recognition that the forecast was only an intermediate step and not the goal itself. For this, several simulated examples were used to show that even with an imperfect forecast the pricing decision could be good enough to achieve near-optimal revenue. (A theoretical justification is that demand curves are downward sloping whereas revenue curves are usually concave and tend to be very flat at the top.) Full validation came again from a controlled field experiment that was conducted in all Belgian and Irish stores during the winter of 2009, and it was estimated that the pricing model increased revenues by 6%. This was equivalent to $90 0612-006-1 UCLA Anderson School of Management Zara: Staying Fast and Fresh million in additional sales that went directly to the bottom line since the model did not have a major impact on Zara's costs. Additional Improvements were made under Isla's leadership, including one that moved a time-consuming backroom store process to the factory. Until 2007, store employees were required to attach alarm tags to new merchandise. After evaluation, this process was moved off site to be completed at the factory prior to shipping. In 2010, two other ongoing projects were an optimization model to coordinate inventory and pricing decisions and a pilot to test radio- frequency identification (RFID) technology at the store level. The purpose of this last project was to keep a closer control of the inventory levels during the day in order to re-stock in real time those items that were missing on the shop floor but were avaliable in the backroom. Prior to that technology, store associates had to perform store walks to detect these items, which was a demanding task and therefore happened less frequently on busy days when stock outs were more likely. Zara believed that the reduction in lost sales would compensate for the incremental cost of the RFID tags. This had been confirmed by preliminary results from the pilot, particularly for the larger stores that experienced heavier traffic. Zara Goes Online In 2008, online sales in the United States reached $68.9 billion, OF this amount, $18.38 came from mass merchant and department store sales and another $7.18 came from online apparel and accessories retailers, together representing 37% of total online sales in the United States, The size of this market was hard to ignore and Zara carefully considered moving into the e-tail space but ultimately decided that online sales were not right for its business model, which relied heavily on the in-store experience. In an effort to build an online presence without losing brick- and-mortar sales, Zara offered an online viewing catalogue of products but customers still had to visit the store to buy the items. That was 2006. In 2008, The Gap's e-commerce division surpassed $1 billion in sales. In mid-2009, Amazon announced it was purchasing footwear and accessories retailer Zappos.com for $847 million. This acquisition, made by the most successful e-tailer, represented a strong bet on the value of online apparel commerce. Later that year, after almost five years of deliberation, Zara founder Amancio Ortega asked Javier Garcia to spearhead the launch of Zara's online shopping portal, Garcia had built a long career at Inditex, having begun his career at the store level. He continued to grow under the Inditex umbrella and eventually moved into Zara's distribution department, where he assisted with the development and implementation of the model-based inventory allocation system, Garcia was an avid “gadgeteer’ — always interested in the latest products and electronics ~ just like Ortega in the early years. He also knew the company inside out from its customer base to its core processes, which made him a well-suited choice for the job. Zara's online store officially launched on September 2, 2010 atter just one short year of development, a rapid pace that had previously been demonstrated in its manufacturing capabilities. Online shoppers in six countries: France, Germany, Italy, Portugal, Spain and the n612-006-1 “Zara: Staying Fast and Freth UCLA Anderson School of Management U.K. were able to shop online for Zara merchandise which was shipped directly to all locations from the warehouse in Madrid. The products sold online carried the same prices as those found in the store, but they were now available from a simple and convenient website. Moreover, customers had the option to ship their purchase to a particular address for a fee or could ship it for free to any Zara store for pickup. Zara had initially been concerned that the online portal would adversely affect its high Urgeneyllow inventory strategy at the store level. However, there was little evidence that consumer brand perception had changed. in fact, the most notorious change in shopoing behavior was that after the launch, Zara customers began walking into stores and asking sales associates to point out items they had found online, showing the pictures on their mobile hones. Another initial concern was the cannibalization effect between the two sales channels, but that also proved to be unsubstantiated since most of the online sales came from locations where there was no Zara store nearby. in November of 2010, online sales were already noticeable, though most of the volume came from counties like the U.K. or Germany that had a previous tradition in catalog commerce. Corporate Social Responsibility and the Environmental Dimension Zara initially manufactured almost all of its clothing exclusively in Spain, but by 2005 Inditex’s supplier network had expanded to include over 1,800 production facilities in Aftica, Asia, Europe and the Americas. Inditex joined other clothing suppliers in implementing a combination of offshoring and outsourcing for its labor-intensive garments as a way to drive down costs and stay competitive in the market. As more and more apparel companies joined in this globalization effort, concems surfaced regarding unfair labor practices and environmental impact issues such as the use of massive amounts of energy and the disposal of toxic chemicals. Global NGOs and other agencies began reporting large corporations for wrongful labor and environmental practices. Several worldwide campaigns focused on ensuring fair labor practices or denouncing greenwashing received prominent coverage in the press. Inditex, which was becoming the world’s largest clothing retailer, was no exception in the attacks. For instance, in 2004, the organization coordinating the Clean Clothes Campaign in Spain — which had purchased Inditex stock to attend the annual meetings ~ issued a statement labeling Inditex’s social responsibility plan as "a deceitful front’ and claimed that the company was using it to Portray itself in the media as a pioneer in social responsibilty issues in Spain. A more balanced assessment was made by Intermén Oxfam, a development NGO, who gave credit to Inditex’s efforts but also acknowledged the difficulty Inditex faced in matching its aggressive marketing strategy with the ethics code expected from its suppliers.° In response to this increasing pressure from the global community and the increasing challenge of monitoring foreign supplier shops, Inditex decided to revamp its Corporate Social Responsibility (CSR) program. The company initiated several programs that not only impacted labor standards and working conditions in the factories but also sought to improve living conditions and social development in local communities (see Exhibit 9). In 2007, Inditex signed 2612-006-1 UCLA Anderson School of Management “aa: Staying Fast and Fresh ‘an agreement with the global trade union Intemational Textile, Garment and Leather Workers’ Federation (ITGLWF). This agreement, the first of its kind to cover a retail supply chain, laid the foundation for ensuring that intemational labor standards would be observed throughout Incitex’s network of supplier factories. Inditex also made changes to its environmental policies. Starting in 2006, Inditex began publishing its own CO2 emissions in order to showcase its efforts to remain committed to the environment. Despite significant growth in the number of stores, absolute carbon emissions remained relatively flat and actually decreased when measured per store square meter (see Exhibit 10). One program that helped reduce Inditex’s consumption was the creation of the Eco-Efficient Store Manual and training videos to help sensitize and increase awareness among employees on issues such as recycling and the conservation of water and energy (see Exhibit 11 for recent levels of water consumption). Other large environmental projects included the Pro Kyoto initiative whose aim was to reduce CO, waste by 20% and the Terra Project, developed to plant trees and build forests to help offset emissions made by the company. In its 2010 Annual Report, Inditex presented its new 5-year environmental strategic plan. This plan included goals of building new stores and redesigning existing stores to be more environmentally friendly. It also set out a plan to optimize logistical routes and incorporate efficient vehicles with the latest technology. Inditex hoped that these new strategic initiatives would demonstrate its commitment to improving the environment and reducing its carbon footprint. Challenges Continuing Forward Many of the press articles and cases that were written at the beginning of Zara’s expansion questioned whether the company’s operations could support its continued growth. Several years later, we know that the "Zara way" proved itself resilient even through an adverse economic scenario. Zara successfully sustained ten years of organic growth, but can it do it again? Where should Zara focus its efforts and what should drive its expansion from here? Should Zara localize its operations in China given that it will quickly become its second largest market? Would opening a warehouse in China jeopardize Zara's success with a centralized distribution model? From a competitive standpoint, the success of Inditex, and in particular Zara, pushed H&M and Fast Retailing to expand at a similarly rapid rate. What does this mean for the future of the industry? Several other questions remain open. In globalized world, can Zara continue to price so differently from country to country? If online sales are considerably more profitable, is that the way forward for specialty apparel retailers? Are brick-and-mortar stores becoming obsolete? If environmental regulations become more stringent. would that represent a threat or an opportunity for Zara? * Kenna, A. 2011.4 MustHave Becomes a Has-Been. BusinassiWeok March 10, 2011 2 The industry average for advorising expenditure was 3-4% of revenues. * One of tha key employoos was Jose Manu "Pepe" Corredoira who at the time of writing was head of an IT team now fully dedited to analytical model implementations B612-006-1 ara: Staying Fast and Fresh UCLA Anderson School of Management * Caro, FJ. Gallen, M. Diaz, J. Garcia, JM. Corredoira, M. Montes, J.A, Ramos, J. Correa. 2010, Zara Uses Qperations Research to Reangineer Its Global Distribution Process. Inferfaces Vol. 40, No. 1, pp. 71-84. * Caro, F., J. Gallien. 2011, Cleerance Pricing Optimization fora Fast-Fastion Retailer. UCLA Andersen Schoo! of Management, working paper * Vernis, Vilanova and Figueroa. 2006. Incitexc Outsourcing in Tangier. ESADE Business Schoo), “4612-006-1 UCLA Anderson School of Management ara: Staying Fast and Fresh it 1: Previous Zara Cases (up to 2010) veo ne roa 2am erows se AD Mach Mile Garston ey Onan 2 finan Wl Sigh Und Ang canta coumbatusnes | OPS 2m |esuatate wae DenauceenderMayle EAD Seer 2 [pnt chron 8 ose is Mun nar Buses St Seater 2m | rma Dade On roi Hor Buns Sho satin a nce btn cara oe Ses Sd soatey as [omc hr UN kts [erent | a |i ee, ces Ander Sonn vard Bana Sa! " 200 | tne Toa C8 Vincent Des Hava uses So NROperatons Source: case writes, Exhibit 2: Zara Store Growth and Significant Events el lei ‘00 Zaareveruefitions numberof pooi:e2az7 stores 9 pores ae 2o10-€2088 ‘Note: includes Zara Kies which accounted for 208 stores in 2010, ‘Source: case writers, rom company annul reports and Inditex SA 15612-006-1 Zara: Staying Fast and Fresh UCLA Anderson Schoo! of Management Exhibit 3: Competitive Landscape, End-of-Quarter Stock Prices Jan-07 to Oct-10 zak [sap RETAIL] sap 500 ReTaLING| (xT) | (SPY) in Pr vano7fe 4347/$ 1947| reacoe|y ateao|s 4196]§ 14375 aproie 4538]$ 1795|/20325€]x 9,50]/§ 4309|$ 148.29 sulo7]e 4437] 1720] 195.75€]% s400|$ a9ss|$ 145.72 octo7}€ 5235] 1890] 21150¢]¥ 6920)$ 3851|$ 158.65 sanos]€ 3350] 19.09] imio0¢e}¥ 7810]$ 3400|$ 13737 aprog]€ 2498] 1862| 17800¢€]¥ 9570]$ 3300|§ 138.26 sutoa}e 31.05]$ 1512] r62s0€|¥ 9,790]$ 3039|$ 12583 oceos}e 2636] 1254] a3800€}¥ 12370[$ 2311|$ 96.83 san-og}€ 2988 /'$/ 1128] s6200¢}¥ 12670]$ 1967] 5) S223 aoros}€ 3239/$ 1554] sai2se}y¥ a1o00/s 2770/$ 2742 suloofe 3774/5 1632] 214s0€]¥ 12050]$ 3050/5 9882 oceos}< 40.00]$ 2134] 20800¢]¥ 11,780] 33.76 |§ 10356 san-tof€ 45.63|$ 1908] 218.75¢]¥ 16900] 3462|5 107.39 aprio]€ a663]$ 2073] 23220] r6 690] 4276 |$ 11882 wuiaofe s0.75]$ seaa| 22740€|¥ 13430]5 3812/3 11927 octrofe 60.01] 1901 | 25ao€]y 11,730) 43.61 | $1849 (¢) On Nay/91/2010, H&M had a stock spit. Prior prices have been halved Note: gray cals denote () pre-economicdowntumn high; (i) lowest price during crisis; (i) post-crisis high up to Oci-10, On Juiy/5/2017, the closing pricas ware: inctex 63.61, Gap 18.17, HaM 220,30, Fast Retaling 12,280, XRT 54.50, SPY 133.81 ‘Source: case writers, from publiomarket data. Exhibit 4: Inditex Financial Data 2000-2010 Tnmiiowe a 2000 [2006 3007 2008 7 case Ses © 2eje gis ¢ 9485 < gay © «10s € 12507 oa0% Gross Profit © tsmle a7 ¢ S30 € | SoM € | omR € 7a some Gris trsin stam] seam OK SGD Shamans ‘ir € ole 136 ¢ ese a 2a naw Open rain us Mee 7s SaaS tna Net income © mele 10 © ase © ae a 7H aso open som] ets usm% ame aoe Resets © 2ushe 30a € 433 © 4722 € 5m © 6306, Inventory « mele ame € aor © oss as (Operating Working Capital 1054 78% 100% “5% 70% 72% ‘Numboraf stores 0; 3181 361 264 se Bo Numberaf Employees zee] 20 asi7 eae sons a3 of Soles atuibutobieto Zara] 7820%| 675% 66.396 6557 62.ASK_—_—ASOR Note: operating working capitals presented as percantage of sales. Source: Inditex S.A 16UCLA Anderson Schoo] of Management Exhibit 5: Comparable Revenues for Specialty Apparel Retailers $20 315 2 s10 612-006-1 Zara Staying Fast and Fresh ores Hem ‘GaPinc fast RETAIING 2000 2006 2007 2008 2009 2010 Thditex 3 2a2/S 10360 $ 1300 $ iis § 15505 $ 16592 Gap, Inc S 13673}$ 35923 $15,753 § © tasz6 $a $68 Ham S 4308} ga78 $1589 § Baa Sais $5,088 Fast Retailing [$2,107 3s § 44 $5495 $718 $8,277, ‘Noto: milions of US dollars; exchange rates derived using a 965 day average for fiscal year (Fab 1 - Jan 31), ‘Source: annval reports for respective companies. Exhibit 6: Location of Inditex Warehouses and Logistic Centers (2010) aE — SCE elas SE bee eee ‘Source: Inditex S.A, 7612-006-1 Zara: Staying Fast and Fresh UCLA Anderson School of Management Exhibit 7: Before and After of Zara Landmark Stores in Salamanca and Elche Source: inditex S.A Exhibit 8: Inditex's Expansion Strategy Planned FY 2040 Actual eae Openings _|*0¥ss186 $P2IN| store Openings laa 110-120 om Ts Hera Home 25.30 65% 2 Pull & Bear 40-50 95% 56 Massimo Dutti 25.38, 90% aa Bershka 45-50 98% 9 Stradivarius 65.75 95% B loysho 3035 20% 0 luterque 25:30 65% 2a [TOTALNET pace 365.425 95% 405 Source: Inditex S.A, 1BUCLA Anderson School of Management 612-006-1 Zara: Saying Fast and Fresh Exhibit 9: Corporate Social Responsibility Programs, Suppliers Inston internal Coce of Conduct Formal decaration of vaueewhichragste the labors of jnditx with each one ofits interest aroupssharehode's, lemployees, customers, business partes, spgliersand sede lingeneral [code of conduct for xtemal Manufacturers and Workshops [roma cecaration of values developed am the nieral Code lt Conduct which sets the principles which regulate the [lationship botweenInditx and ite sulle: Mefied ia lan, afteroiningthe Ethical Tradinginlasive andthe Incorporation of Base Code, tinudes many iO Institutions lnuturiber Agreement Forum (MFA) [MatiberAyeerent Foran (MFA) isa dialouDe platform lwhich promotes soci espensbity of exile Indusiles in Icuntrie that ar vulnerable ethical rade nitive (ET JE san organ sation which Brings together Internavoral [lstibution companies, large supplies, trade unions and NGOs |ansseich alms toimareve the lining conditions ofthe workers nthe supying compsries. beter work rogram better work Program aime tovnereae, na sustainable mann, the competitiveness of certain emerging counties, based cn lhe promotion respect and encouragement of basic Human an lemployeent igh. customers Produc heath sander aeaedin tos, Reaiates, lctearco wear lcompostion, pas wellas substances thar nave limited egal ses (eg formaldehyda) inked wall ge reactions. I productsafty standard which egates metalic iste towear lomarination, designs ste laces for children under iis IMarabity inthe dotting, ee society JProrrams of Community Development [Supely the wool nein forthe hammoriovsererdeefe |vide concept of deveioumert, based onthe extension of boinc, sock, traning and economic apa of hoee [smsities, insittions and organ aod groupe tate clase lo ouraciviy Monitering Programs JPopams of socal investment which encourage acute Joeace ana, as consequence, ve recovery an rehabltston of Ine soca fabicthough the funding of ertin heat, cn) land educational poject emergency Programs hough the Emergency Proaraimesintexparicpatesin Jorojecsof intervention designed alleviate the negative Jonsequence of natal catastrophes which have ceed in ine wo [oracFrom Programs incitex colaborates with the El olid'en Puigvert Foundation bra the Galician Confegerauion ofthe isa6e¢ (COGAN in projects or the creation of spaces fr ghinglobs to persons with physical and/or mental esses Source: Inditex SA 1612-006-1 aa: Staying Fast and Fresh UCLA Anderson School of Management Exhibit 10: Carbon Footp = Global CO; Emissions -| i: z" oss 16 ie us = bs | ree ot ast ee os 27 awe 2 2210 ser “rc inspec ee 72) Source Inditex SA Exhibit 11; Water Consumption [a0 a20 . F soo E50 os 300 | 3 ox S250 | ss | $200 os as | Bio oss au bi = oz Bo oxo 2006 2007 2008 2009 2010 ‘Water Consumption “®Water Consumption per Store Squate Mater o993/m2) Source: Inditex S.A 20