Zara’s Supply Chain Managment Essay.
This case essay provides a business analysis on Zara–the most profitable and well-known fast fashion brand under the world’s largest fashion distributor Inditex Group. The analysis will evaluate Zara by using Porter Models, looking at its Supply Chain Management and defining its current IT challenges. Then, the essay will discuss the costs and benefits of upgrading to the new OS systems. The essay will give recommendations on whether Zara should upgrade its POS terminals after considering all above factors.
Founded by Amancio Ortega, the richest man in Spain and its biggest shareholder, Zara is a clothing and accessories retailer that opened its first store in La Coruna, Spain in 1975. Zara has been operated under Inditex Group, the world’s largest fashion distributor, since 1985. Zara was originated on a simple business idea explained by the CEO of the company Jose Maria Castellano Rois who joined Inditex in 1997 that: Link customer demand to manufacturing, and link manufacturing to distribution.
(McAfee, Dessain, & Sjoman, 2007) As a flagship chain store of the company, Zara plays a very important role in the Inditex Group. By 2003, Inditex has 1558 stores in 45 countries which nearly one third of them were part of the Zara Chain. For the fiscal year of 2002, Inditex’s net income was posted as €438 million on €3,974 million revenue, which Zara alone generated nearly three quarters of sales. Women clothing accounts for 60% of Zara’s sales, and Men’s and Children’s segment each accounts for about 20%. (McAfee, Dessain, & Sjoman, 2007) Zara’s operation system is very critical.
Compare to other companies that it takes them about six months to develop a product and deliver it to the store, Zara only needs three weeks to complete the whole procedure. And Zara launches about 11,000 garment items on average each year. (Business Week, 2006) Only the fast speed of Supply Chain Management (SCM) can assure Zara to respond very quickly to the demand of target customers who are young, fashion-conscious city dwellers. And to reach its goal to quickly respond to customer demand, Zara developed three cyclical processes from ordering to fulfillment to design and manufacturing. Zara’s Information Technology has matches its preferences for speed and decentralized decision-making. There’s no CIO within Zara, but instead, Salgado and Castellano are on board of the technology committee who makes decisions around IT.
Due to Zara’s business uniqueness, most of its IT applications are established internally by its IS department rather than buying commercially available software or outsourcing. At August 2003, Salgado and Sanchez must make a decision on whether Zara should upgrade its operating system or not. In every Zara store, there are basically two technological systems that are used—PDAs (short for Personal Digital Assistant) and POS (Point of Sales) terminals. PDAs are handhelds that were used primarily for ordering and were upgraded constantly.
POS terminals are cashier computer systems with Zara’s own application installed and had remained unchanged for over a decade. Zara, at 2003, was using the DOS operating system that was no longer supported by Microsoft. The POS application that was ran on top of the DOS system worked very fine and efficient for Zara so Sanchez insists on not changing it. Salgado, on the other hand, thinks that there are potential problems with the outdated system and there are rooms for improvement if they upgrade it with a new system. As far as the debate could go, the two men need to agree on a decision and come up with a solution for this challenge.
To help Mr. Salgado and Mr. Sanchez to solve this tough problem, we need to firstly understand Zara’s business model. I will use Michael Porter’s Generic Strategies, Five Forces and Value Chain to analyze Zara Company.
Among the three generic business strategies Dr. Porter identified, which are (1) broad cost leadership, (2) broad differentiation, and (3) focused strategy, I think Zara inherited both cost leadership strategy the differentiation strategy. Zara differentiates itself from the rest of the clothing industry not only by offering unique products but also by having full control of its operation processes. As Daniel Piette, LVMH’s fashion director, described as “Possibly the most innovative and devastating retailer in the world”, Zara truly has its unique business philosophy. (CNN Business, 2001) Zara meets its customers’ expectation by delivering the latest fashion lines at affordable prices the soonest it can. This concept itself is unique enough. Unlike high-end designer brands that offer limited exclusive lines at big prices, or like some other clothing retailers that offer trendy styles at low costs but poor qualities, Zara is able to bring the newest fashion into mass production and deliver them to people with a normal quality for very good prices.
While most of the clothing or textile companies rely on outsourcing and cheap labors from China, Zara established a vertically integrated operation system. (Osterwalder, 2005) Customer demands are Zara’s heavenly goal, and Zara collects them from its stores throughout the world. Zara has its own “commercials” that make decisions on what to design and produce. Zara owns a group of factories around La Coruna and near Spain to finish manufacture and production quickly. Zara is able to use this network to move a new design from concept through production and into the Distribution Center in as little as three weeks. And deliveries to the store usually take only one to two days via various transportation methods. Jeffrey Ballinger, a Harvard researcher and director of pressure group Press of Change, said that. “Zara has turned control over garment factories into a competitive advantage.” (CNN Business, 2001) Zara’s differentiation strategy results in a low cost strategy.
Zara uses a low cost structure than its competitors to cut cost. Unlike fashion brands that creates or used well-known designers or design groups that cost millions of dollars, and produce with exotic, rare to find fabrics. Zara takes its designs from its “commercials” and use easy to find textile to not only react to changes quickly but also cut the majority of the cost, therefore, Zara can always offers a lower price. Zara’s generic strategies—both differentiation strategy and low cost strategy are due to Zara’s closeness to its customers. Zara’s designs are generated from preferences collected in the store, and Zara is able to satisfy its customer by taking full control of the operation process and therefore, fulfilling customers’ demand quickly. The ability to transform this close relationship into a value proposition gives Zara complete advantage over its competitors. (Osterwalder, 2005)
Michael Porter’s Five Forces can be used to identify Zara’s competitive forces within the environment to assess the potential profitability in the clothing retail industry. According to Paige Baltzan, Five Forces’ purpose is to “combat these competitive forces by identifying opportunities, competitive advantages, and competitive intelligence. If the forces are strong, they can increase competition.” (Baltzan, 2010) Below, I will discuss Zara’s competitiveness from the five forces.
1, Buyer Power—is the ability of buyers to affect the price they must pay for an item. (Baltzan, 2010) Buyer power is not very strong in Zara’s case. Customers who buy from Zara know exactly what kind of merchandises they are purchasing from this brand—trendy fashionable items with a normal quality for a good price. Since Zara has 531 stores over the world, it has a large number of customers. Since Zara’s garments have “fairly short life spans” (McAfee, Dessain, & Sjoman, 2007), it creates a sense of urgency for customers. Customers know that if they don’t buy the item this time because they are hesitating on the price, they may not even be able to find it next time they visit the store. This gives Zara power to name its own price, but of course, within a reasonable “Zara price range”. Although there are brands like Gap, H&M, Benetton and so on to compete with Zara, the unique fashionable items that are offered at Zara, which change constantly, makes the switching costs high for Zara. There are definitely loyalties in Zara’s customers who check out the store frequently hunting for new items as soon as they are available.
2, Supplier Power—consists of all parties involved, directly or indirectly, in obtaining raw materials or a products. (Baltzan, 2010) Zara’s operation structure gives it a comparably lower supplier power. Clothing retail industries rely on their manufactories to produce their garments, so usually their suppliers have high bargaining power. If the price of cotton goes up, the whole industry is likely to be influenced and therefore, their cost will go up, their merchant price will rise as well. However, since Zara owns its factories, Zara is its own supplier. Supplier power is comparably lower than its competitors.
3, Threat of Substitute Products or Service—is high when there are many alternatives to a product or service. (Baltzan, 2010) The thread of substitutes is low for Zara. Even the fashion industry is very unpredictable and Zara has a lot of competitors wanting to make the next big fashion trend, Zara is still distinctive because it is known for constant innovations and designs for the latest fashion. No competitors of Zara could catch up its speed on producing so many items a year and deliver that fast.
4, Threat of New Entrants—is high when it is easy for new competitors to enter a market. (Baltzan, 2010) The enter barrier to create a company that is similar to Zara is high so the threat of new entrant to Zara is low. Profitability always attracts investment to enter the industry, and in fact, there are new entrants all the time. However, Zara’s business model is quite unique and difficult to copy. Zara has already built its reputation, and is the leading company in the industry. It will be hard to achieve what Zara has. It also takes time and capital to establish a successful company like Zara. It is hard to gather all the resources including talented people like what Zara has to create an industry giant. There are going to be some threats of new entrants but not that big of the influence to Zara.
5, Rivalry among Existing Competitors—is high when competition is fierce in a market. (Baltzan, 2010) Since there is not many similar fast fashion stores in the market, Zara’s rivalry is low among existing competitors. Zara’s existing competitions come from sharing the same clothing retail industry, but not so much from what Zara is specialized in—fast fashion. So again, Zara distinguishes from other competitors for its products and speed, and so far competition for Zara is not that fierce within the market.
Value Chain Analysis
Support Value Activities
Michael Porter created value chain analysis to identify competitive advantages by viewing a firm as a series of business processes that each adds value to the product or service. (Baltzan, 2010) By identifying Zara’s value chain, we can determine the ways in which Zara can implement IT or add value to its products and services.
Primary Value Activities
As it was described in the case, Zara’s primary value activities are Ordering, Fulfillment, Design and Manufacturing, Distribution and Store Operations. Store managers at Zara place an order to La Coruna twice a week encompassing both replenishment of existing items and initial requests for newly available garments. Commercials at La Coruna then fulfill and ship clothes to stores to satisfy their orders. Zara has its own team of design who amazingly produce approximately 11,000 new items a year. Zara also has a vertically integrated manufacturing operation system that moves its design to production quickly. Zara’s distribution center then transport and distribute Zara products to stores. Zara stores are responsible for selling items and collecting customer preference for fashion trends. These primary activities consist all basic business activities happen within the company everyday.
Zara’s Support Value Activities, like many other companies, are Administration, Information Technology, Human Resources and Procurement. Zara’s approach to IT is consistent with its preference for speed and decentralized decision making. (McAfee, Dessain, & Sjoman, 2007) IT team, who creates most of the applications that Zara uses internally, supports Zara to function the best way it can and supports well. Zara’s IT is used in store operations, logistics, administrations and so on. It has reduced the overhead cost in many areas, and therefore, has helped Zara to achieve a cost advantage.
Implementations of Porter Models
Zara differentiates itself from the rest of the industry for its concept of fast fashion at an affordable price. And this is done and supported by not only Zara’s talented employees such as powerful store managers and commercials but also by the IT Zara employs. Information plays an important role through Zara’s supply chain management. Information of customer preference was collected from the store and transferred to commercials so that they can generate the right products quickly. Information of SKUs (stock-keeping-units) was communicated so that the Distribution Center knows what to replenish to stores twice a week. IT adds value to Zara in almost every primary and supportive activity in the value chain. Zara used IT in terms of functional processes and decision level.
Even Mr. Sanchez states that the current system is stable, effective and easy to use, there are still many potential risks and problems and there is a big room for Zara’s IT to improve so that the operation could perform even better. Zara POS terminals are run on DOS operating system that is not supported by Microsoft any more. Zara also uses the PDAs to make orders and handle returns. (McAfee, Dessain, & Sjoman, 2007) As important as sales information is, Zara’s POS terminals were not connected to one another via any in-store network, so employees have to transport all the information on a disk and to the one modem-equipped terminal to accomplish transaction.
This process is inefficient and has many potential risks of losing the information. PDAs also use the same terminal’s modem to receive the offer and transmit the order. Within a store, POS terminals and PDAs could not share information. That being said, one the terminal modem is dead or has some kind of flaws, the whole store operation will be delayed or stopped. Then, Zara will lose its competitive advantages from its five forces in the market and less value will be added to the value chain. As a result, its generic strategy won’t work as well.
The question is: should Zara choose to upgrade its POS system? Nicholas G. Carr explained in his article It Doesn’t Matter that IT has lost its ability to create a sustainable competitive advantage and suggested companies not to try new technologies but follow the ones that have been tested to reduce risks. (Carr, 2003) But from the study of all publically traded companies in the article Investing in the IT we learned that there is an industry concentration that large share of the market is concentrated from a small number of companies. (AcAfee & Brynjolfsson, 2008)
As where Zara stands in the clothing company, it definitely doesn’t want to lose its competitiveness as one of the small group of companies who hold a large piece of pie from the market. The case problem is a semi-structured one since we only know some of the valuables and it is hard to measure the future value of the result. Peter Drucker said that “If you can’t measure it, don’t do it.” Within Zara company, Salgado and Castellano were only involved early in discussion of initiative that might include computerization. They only determine what new system there is department should purchase or who should work on them without further conductions for cost/benefit analyses. However, I will give a financial forecast using the numbers given in the case to show whether upgrading the system would add value to Zara or not.
From Exhibit 13 of the case, we can collect some data and ideas of how much it will cost Zara if it decides to upgrade the system. The company can try the new system in a few stores first to test the efficiency. However, my calculation is based on installing the Windows Operating System throughout all 531 Zara stores average five terminals per store within a year. (Despite new store openings) Total cost to purchase and maintain the Windows OS system per terminal is €170. Hardware required to install in the store including POS terminals, wireless router and wireless Ethernet card cost €5,430. High-speed Internet connection will cost €240 per store annually.
Time required per store to install new POS terminals with new POS application, establish wireless network and train staff is 32 hours, which convert to four days of work. Cost per day will be €2,000 times four days, and that gives €8,000 expenditure per store. So, total cost per store to completely install the new OS system with new POS application ready to perform daily tasks is €14,520. Total programming time required to port existing POS application to new OS and expand POS application to include some new features is 20,000 hours. Assuming that computer programs can be run on the machines 24 hours a day, each day cost €450, total cost will be €375,000. As a result, 531 Zara stores will cost €7,710,120 to install the program, plus €375,000 expenses from the IS department, total cost to upgrade the POS system will be €8,085,120. (See Exhibit 1)
Since Zara generated 73.3% of the Inditex Group’s sales, Zara’s Net Operating Revenues can be estimated at €2,913 million in 2002. And assume all companies under Inditex Group operate in the same way and share expenses equally as sales, Zara will make €313.8 million Net Income. (See Exhibit 2) The €8 million upgrading expenses will count for a 3% investment for Zara.
A €8 million IT upgrade is not a small investment, we need to look at potential benefits that can be made out of the system to measure if it makes a profit for Zara. In another word, we need to forecast future returns to see if the new system will add value to Zara or not. I will use some Key Performance Indicators (KPI) and some Critical Success Factors (CSF) to analyze the outcome.
There are some tangible KPIs we can measure to see if Zara benefit from the new system. I will use Revenue, number of garment, percentage of time saved using the new system as my KPIs. Every business is about making money. If the new system cannot bring Zara extra revenue, why invest? Let’s suppose that the system runs smoothly and well once it is installed. Hopefully it will link up the POS terminals and PDAs that are used in each store to headquarter automatically using the wireless Internet. Added new features are supposed to enable staff to check theoretical inventories from the store as well as all other Zara stores near it. The system will minimize faulty transactions from human errors. Staff in the store does not have to record sales numbers and transport it from one terminal to another.
More information from customers and store managers can be collected and sent back to commercial teams quicker and more accurately. Distribution Center will be able to see store inventories from the system simultaneously so replenishment can be made without making an order. Shipment can arrive more frequently to the stores. Let’s say the system accelerate the whole operation process by 10% of the total time, and the design group is able to make 10% more garment items a year due to the time they saved. That will make a total of 12,100 items a year compared to 11,000 before. Revenue can be increased to €3,204.23 million from €2,912.94 million. Although the number may be too positive, it gives us an idea that multi-million of revenues can be made due to the increased efficiency of the system.
Another important fact is that the new system installed will last for a period of time, not just one year. The current DOS system has been used for over a decade, and I believe the new system can be run for about the same period. The IT investment expenses can be distributed over the next few years and Zara will continuously benefit from the uses of the system.
There are also some intangible values that can be added from the new system. Some Critical Success Factors include market competitions, Supply Chain Management, Customer Relationship Management and Material Resource Planning II.
The new OS system will help Zara to be competitive in the industry. As an innovative company, Zara has its unique and simple business model that has a proven success. The IS department of Zara that create program application for Zara to use is a valuable Proprietary Technology benefit that Zara owns. It is beneficial because no other competitors have access to the technology. Infrastructural Technology such as this DOS or new OS system has better value when more users are taking advantage of it. (AcAfee & Brynjolfsson, 2008) Zara should take the advantage by also applying the new OS system as many other competitors in the industry have already used it. Thus, Zara will have both benefits from both proprietary and infrastructural technologies and stay competitive in the market.
New OS system will link Zara’s supply chain better and faster. Zara’s business model decides that the company wants to exchange information and it wants the information to be exchanged fast. Zara’s supply chain links from Supplier to Manufacture to Distributor to Stores and to Customers are tighter than many other companies because its products turn over more frequently. Zara needs a good system to perform operation than any other companies. Having an upgraded system will help Zara to achieve its business goal.
New system will bring more customer satisfaction to Zara. A lot of Zara’s customers have some degrees of loyalty to the company and their satisfaction is important to Zara. Despite chatting with customers for their fashion sense when they are in the store, Zara doesn’t make much networking effort with customers. Product says it all. Zara simply keeps its customers coming by offering their favorite items. These fashion-forward, young city dwellers come to Zara enthusiastically want to buy what they like. So, being able to check inventories in nearby stores when a customer’s size runs out is very important. The new system will let Zara do that.
Material Resource Planning and Labor will also be better off with the new system. Zara’s vendors have promised to follow Zara’s IT system so it was not really problem. Yet, Zara shouldn’t be standing on the passive side to wait until when it has to switch to a more up-to-date system. By taking the lead, Zara gains more flexibility and comfort to utilize resources it needs. The new system will also fix and install some new features that Zara’s employees have being requesting for. Keeping the labor force happy is essential since talents (people) are the key factor that makes it hard for other companies to copy and apply the same IT and business model Zara has successfully. (AcAfee & Brynjolfsson, 2008)
Some main reasons that Sanchez pointed out to support his idea of not upgrading and some other factors that need to be considered are discussed below. Mr. Sanchez worries that switching to the new system will turbulent the stable usage of the current system and cause troubles. We have to admit that what he said could happen. That’s why we take close consideration of it to prevent it from happening rather than not to do it. The current system is effective, stable and rolls out easy to use for employees because it has been tested and run for more than ten years. Staff is familiar with the system, and IS department knows how to fix it when there’s a problem. However, this shouldn’t stop Zara from innovations. Zara can plan on installing the new system and test it with a small number of stores first and slowly transformed the rest of the company to use the new system.
Zara may also face the difficulties to train employees to use the new system, or the system doesn’t work perfectly for Zara at the beginning phase, and therefore, causing systematic troubles that affect the business negatively. Yet, generally speaking, these software interfaces for businesses are easy to use. Not to mention that Zara has a strong IS department that can support its technology uses.
In the process of new system development, Operation/Maintenance consists 80% of the time and cost while User Acceptance only contains 20%. That being said, maintaining the system and Auditing the system after it has been installed is crucial. Zara’s IS department should pay more attention to them.
Overall, there are more benefits and predictable profits than shortcomings to upgrade the outdated DOS system for Zara. Conclusion and Recommendations
Taking into considerations of all possible factors, I believe that this case analysis is in favor for Zara to consider upgrading its outdated DOS system to OS system. As a successful fast fashion clothing retailer, Zara’s business idea, which links customer demand to manufacturing, and links manufacturing to distribution, works very well and keeps Zara a flagship chain store for Inditex Group. Zara’s generic strategy is to differentiate and save cost. Since Zara has a strong demand for speed in the operation process and tight links in Supply Chain Management, its requirement for IT is high. The evaluation of the solution shows us that there are more predictable advantages than disadvantages for Zara to upgrade its system. With thoughtful considerations and backup remediation plans, Mr. Bruno Sanchez shouldn’t be so conservative and against the idea to upgrade the system. I am confident that upgrading the system will meet Zara’s business goal to be the most innovative and profitable fast fashion retailer in the industry.
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