Assignment 1. With which international competitor listed in the case is it most useful to compare Inditex’s financial performance? What do comparisons indicate about Inditex’s operating economics? Why? There are 3 key international competitors mentioned in the case: The Gap, H&M and Benetton. The Gap‘s production was internationalized with more than 90% of it outsourced outside of the United States. Its stores, however, were US centric. Therefore, The Gap’s strategy was to own most of its stores, while outsourcing all production.
The same was the case with H&M. Benetton on the other hand had a completely different business model; it had invested relatively heavily in production, but licensed its stores to third-party operators. Of these competitors, probably the one which is most useful to compare Inditex’s financial performance to is H&M, which was considered at the time of the case Inditex’s closest competitor. Inditex and H&M are both based in Europe and have a strong focus on international expansion.
They are both placed in the 4th quadrant of the Product Market Positioning Map, which means they are both fashion forward but at lower prices. When we look at the financial status of both companies in the Exhibit 6, they seem to be very comparable. However, a closer analysis reveals that Inditex has enjoyed a competitive advantage in operating metrics over H&M. The following is a summary of the various ratios that can be used to compare the profitability and efficiency in operating economics for both companies: Financial Ratio| Inditex| H&M|
Zara Positioning Map
Current ratio = Current Assets/Current Liabilities| 1. 023| 3. 398| Operating Margin = Operating Income/Net Sales| 21. 67%| 13. 1%| Although several such ratios can be calculated, the two above are crucial in trying to understand the operating economics. We can see that the Current ratio for Inditex is much lower than that of H&M, which means that Inditex is less liquid as compared to H&M. This can be attributed to the fact that because of its short time cycles and continuous manufacturing of new merchandise (quick response), Inditex was able to achieve smaller inventory levels than H&M.
The operating margin for Inditex is more than 1. 5 times that of H&M, which means Inditex is able to achieve greater profit per sale as compared to H&M. This is the result of lower operating expenses, vertical integration in terms of in-house production and lesser advertising expenses compared to H&M; all of these activities led to Inditex’s higher margins. 2. How specifically do the distinct features of Zara’s business model affect its operating performance? In order to make comparisons with other firms you can assume that retail prices are twice the manufacturing selling price). The following key features of Zara’s business model provide it with competitive advantages and improve its operating performance: * As opposed to the traditional industry trend of outsourcing all production/manufacturing to countries with cheap labor, Zara has evolved a unique business model that combines internal manufacturing (for fashion-sensitive products) and external outsourcing. Zara made major investments in manufacturing logistics and IT, including a Just In Time manufacturing system. * Zara employed advanced telecommunication systems to connect headquarters and supply, as well as production and sales locations. This approach of proximity to reduce transport costs worked well for Zara in the long run. * Zara’s designers continuously tracked customer preferences and placed orders with the internal and external suppliers accordingly to be as relevant to-the-minute as possible with demand.
About 11,000 distinct products were produced as compared to the industry average of 2,000-4,000. * Production at Zara took place in small batches with vertical integration into the manufacture of the most time-sensitive items. This vertical integration helped reduce the “bullwhip effect” in Zara’s supply chain. * Products were shipped directly from the central distribution center to well located attractive stores twice a week, thus eliminating the need of warehouses and enabling low inventory levels. Zara was able to design, produce and deliver finished goods into its stores in 4-5 weeks in the case of new products and 2 weeks for modifications, as opposed to traditional industry average of 6 months for design and 3 months for manufacturing. * This quick response system, enabled Zara to reduce the working capital intensity and facilitated continuous manufacturing of new merchandise; thus giving Zara an edge over competition throughout peak seasons. * Zara’s management, as well as staff and IT advancements, helped it track customer preferences which were hen used to keep production consistent with demand. * Zara spent just 0. 3% of its revenues on advertising, keeping expenses low. * Zara was able to successfully create an atmosphere of scarcity and opportunity in its retail stores thus encouraging customers to return more often for shopping (e. g. Zara customers shopped 17 times a year at Zara stores, as compared to the industry average of 3-4). This also allows the company to sell more items at full prices, thus reducing the percentage of items sold at the marked down price as compared to other competitors.
Such distinct features of the Zara business model which adds value to almost every aspect of the value chain, makes Zara stand apart from the competition and improve its operating performance. 3. Fashion sensitive products – internal manufacturing Can you graph the linkages among Zara’s choices about how to compete, particularly ones connected to its quick response capability, and the way they create competitive advantage? Effective Merchandising ZARA – Fast Fashion at lower prices Highly streamlined and vertically integrated Retailing
Flexible Sourcing & Manufacturing High fashion content Rapidly changing product lines Sense of scarcity Highly motivated store managers Lower marked down prices Rapid turnover Lower inventory levels Small product batches External manufacturing Short cycle times – JIT Direct shipping Low transportation costs Dual shifts for better utilization No warehouses Quick response System Centralized distribution facility Well located attractive stores Minimal advertising Repeat Customers Low failure rates on new products Pro –active Product Development Team