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A Critical Market Analysis of the Operations Management Challenges at Zara

24 Apr 2024,6:38 PM

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Introduction

Zara is the world’s fastest-growing fast-fashion retailer. This case study's critical examination of the company’s OM and supply chain management (SCM) demonstrates several strengths, particularly in Zara’s OM’s performance objectives of quality, speed, flexibility, and dependability. However, the company’s focus on speed, flexibility, and dependability is at the expense of cost efficiencies, indicating that higher costs relative to competitors are the main OM problem at Zara. Zara can solve this problem by strategically outsourcing non-critical elements of its operations and supply chain. The methodologies justifying this outsourcing recommendation include the decision logic of the outsourcing framework, the strategic trade-off balance, the efficiency function, and the order winners concept.

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Background to Zara

Zara is a household fashion brand and the core brand of the Spanish retail conglomerate the Inditex Group. Industry rankings position Zara as the world's fastest-growing fashion brand, accounting for 65% of the 34.5 billion that the Inditex Group sold in 2022 (Inditex, 2022). With more than 2,250 retail stores globally, effective OM and SCM are responsible for Zara’s success (Aftab et al., 2018). Zara leads the global fashion industry in pioneering and implementing the fast fashion OM and SCM model (Song, 2021). More precisely, this analysis can use the 'four Vs' operations model to understand and characterise the nature of the retailer's operations. This model postulates that the effective operations framework comprises 'four Vs': volume, variety, demand variation, and visibility (Hofmann, 2017). According to the current research evaluating Zara's OM and SCM, the company's operations have a high volume when using the inventory turnover metric to compare Zara's operations against comparable clothing retailers. The inventory turn measures OM efficiency computed as the number of cycles the company sells and replaces inventory within a specified timeframe, typically a year (Cohen and Malik, 1997). Aftab et al. (2018) and Song (2021) have a higher operations volume than the typical clothing retailer, with approximately 12 inventory turns annually compared to the 3 to 4 fashion industry average, succeeding in changing fashion styles roughly every 2 weeks compared to every 2 or 3 months for competitors (Rao and Young, 1994). This quantitative data indicates that Zara's operations have a high volume.

The data regarding Zara's operational variety also shows that it outperforms comparable fashion businesses. According to Xuejie, Chang, and Chung (2019), Zara carries more than 11,000 distinct fashion items annually compared to the industry average of 2,000 and 4,000 items annually. Moreover, the global fashion industry is inherently characterised by high seasonality and a short product life cycle, implying that Zara's operations have high variability (Quan, 2023). Finally, Zara's operations' visibility is low because of the considerable time lag between Zara's production of items and its customers' consumption (Wen, Choi, and Chung, 2019). The time lag reduces the transparency and availability of information for use throughout the operations process. Understanding the 4Vs of Zara's OM, as summarised in Table 1 below, is essential to provide a foundation for the critical analysis of the company's operations in the discussion's following sections.

Table 1: The Four Vs of OM at Zara

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Critical Appraisal of Zara’s OM

To be fully effective, Zara must meet five OM performance objectives recommended in the current OM literature: quality, speed, dependability, flexibility, and cost (Myers, Borghesi, and Russo, 2006). In other words, a holistic evaluation of Zara’s operational performance must consider whether and to what extent it delivers high speed, high quality, high flexibility, high dependability, and low costs.

Strengths

The starting point in critically analysing Zara's current OM and SCM is to consider the extent to which its operations are consistent with its business strategy. Simchi-Levi (2010, p. 21) states that a cardinal OM rule is that the firm's customer value proposition must drive a firm's operations strategy, while Khoja et al. (2019) emphasise that a firm's operations must drive its business strategy and support its position against competitors. Zara's value proposition emphasises "offering the latest fashion trends to meet customer demands, using high-quality standards at attractive prices" (Inditex, 2022, p.28). Therefore, this business strategy reflects the company's OM perspective into its business strategy. Based on the business strategy above, Zara emphasises high quality or being right, fulfilling customer demand as fast as possible or being fast, through a high inventory turn and shorter product that reflects a focus on being on time, and attractive prices reflecting lower cost (Table 2)

Table 2: Zara’s Business is aligned with the performance objectives of OM

 

More specifically, Zara delivers its performance objectives through several OM strategies. A lean and agile supply chain helps the company to achieve the speed, dependability, and flexibility performance objectives. Zara holds very low inventory levels, "typically only a few pieces of each model," while reducing its stores' out-of-stock risk through a higher speed and frequency of small-batched orders (Nakano, 2019, p.74). Zara stores receive deliveries twice weekly within two days of the order, enabling Zara to change designs every 2 to 3 weeks compared to its rivals' design changes every 2 to 3 months, with 12 inventory turns annually compared to its competitors' 3 to 4 times annual inventory turn average (Song, 2021). Zara's additional speed-enhancing lean practices include delivering orders already placed on hangers with attached price tags to move products straight from delivery tracks to the sales floor. Tracking store-level demand also supports lean manufacturing in short, 2- to 6-week demand cycles, enhancing demand forecast accuracy with real-time manufacturing adjustments to evolving customer preferences (Song, 2021). The company can also stimulate demand through the short cycle time, which creates scarcity, exclusivity, and a sense of urgency for consumers to buy items, knowing that they quickly sell out. Zara has benefited from stimulating demand, with the average customer in Spain visiting a Zara store 17 times annually compared to the average of 3 store visits for its competitors (Aftab et al., 2018).

Zara's vertically integrated operations are a major strength for its performance objectives. The company manufactures roughly 50% of its products in 20 Spanish factories, only outsourcing simple or labour-insensitivities to external contractors, 70% in Portugal, and 30% in Asia and North Africa (Inditex, 2022). It purchases 40% of its fabric and dyes internally from other Inditex subsidiaries, with the remaining materials sourced from globally distributed suppliers, none of which supplies more than 4% to Zara, to minimise external supply chain risks while encouraging high supplier responsiveness (Nakano, 2019). It collects and distributes all raw materials and finished products from a single company-owned state-of-the-art distribution centre in Spain called the Cube, where it can implement rigorous product quality standards and quality validation. This vertically integrated SCM and OM framework is, thus, critical in supporting the company's performance in assuring high quality.

Vertical integration also supports the company's just-in-time (JIT) manufacturing and lean operations, allowing Zara to scale manufacturing and production based on real-time market demand. The current quantitative data shows that Zara only manufactures 50% to 60% in advance versus the industry average of 80 to 90%, supporting its lean and agile operations (Anwar, 2017). The vertical integration also allows Zara to deploy advanced IT like RFID (radio frequency identification) and advanced big data analytics throughout the operations for centrally controlled real-time granular data visibility and transmission from the points of sale (POS) down to the raw material suppliers (Quan, 2023). Real-time data visibility and analytics support evidence-based decision-making for sourcing, manufacturing, inventory management, and all other OM decisions. The description above demonstrates that Zara's operations strategy is aligned with its operational performance objectives.

Bottlenecks

However, OM performance trade-offs between achieving cost-efficiency, on the one hand, and the other four performance objectives (speed, dependability, quality, and flexibility) constitute a major OM challenge for Zara. Zara prioritises the other four OM performance requirements at the expense of cost-efficiency, which results in a situation whereby it may fail to meet the customers' expectations regarding affordable product prices. For example, most of Zara's fast fashion rivals offer the market lower prices by focusing on cost-efficient operations. Uniqlo and H&M squeeze out as much cost as possible from their operations and supply chains by outsourcing all manufacturing to cheaper labour markets with an average hourly wage of 0.80 Euros (Fig. 2) (Nakano, 2019). Conversely, Zara's vertical integration means it employs roughly 3,000 workers in Spain at approximately 11 Euros per hour, experiencing higher operations costs than rivals (Quan, 2023). These figures and evidence demonstrate empirically that cost efficiencies constitute the primary OM challenge that Zara currently faces.

Additionally, vertically integrated distributions at Zara imply greater logistical costs than competitors, who instead leverage scale economies and outsourced logistical operations to lower logistical costs. Zara's emphasis on responsiveness, speed, and flexibility gives up these low-cost advantages. Zara's responsiveness still allows it to perform better (Fig. 1), selling more than 80% of its items at full price with a low 10% unsold inventory. Zara's rivals must catch up with 60% of full-price items sold with a 17% to 20% annual unsold inventory average (Nakano, 2019). However, drawing from the theory of order winners and qualifiers in OM, the cost advantages that Zara foregoes are still significant because of the potential threat to its current competitive advantages (Rao and Young, 1994). Flexibility, speed, and responsiveness are Zara's order winners, but, over time, with increasing innovation by competitors, these order winners lose their competitive edge and become order qualifiers. The analysis indicates that the main OM challenge Zara needs to address is its operational cost bottlenecks.

Fig. 1: Inditex versus Major Competitors

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Source: Nakano (2019, p.77)

Recommendation

The preceding analysis demonstrated that while Zara's operations strategy is aligned with the performance objectives contributing to this strategy, trade-offs implicit in its emphasis on speed, responsiveness, and flexibility at the expense of cost efficiency constitute an operational cost bottleneck and constraint. Accordingly, this report recommends that Zara consider expanding its outsourced supply chain operations beyond its current largely in-house and vertically integrated model to leverage the cost-related benefits of outsourcing in addressing its OM and SCM bottlenecks. One of the primary competitive advantages that Zara’s market and industry rivals focused on cost-efficient operations strategies, such as Uniqlo and H&M, have over Zara, is their significant outsourcing of manufacturing operations to benefit from low labour costs and other cost-related advantages (Song, 2021). The less price competitive Zara is against its rivals, the more unsustainable its OM, SCM, and overall business strategy.

Therefore, to improve the economic sustainability of its OM and SCM, Zara should bridge the competitive gap with its competitors by strengthening its operational cost efficiencies through a strategic expansion of its outsourced operations. It should begin by first targeting broadening the outsourcing of its manufacturing operations, the main point of the current cost-related operational inefficiencies, as illustrated in Figure 3 (Ivanova, Tsipoulanidis, and Schonberger, 2019). Outsourcing can help Zara address its current cost-efficiency challenges.

Fig. 3: General Overview of the Zara Supply Chain

Critical Evaluation of Recommendations

The methodology of the strategic trade-off balance supports the above recommendation by showing that the advantages of outsourcing can move Zara toward the efficient frontier among all five objectives of OM. From the perspective of the strategic trade-off and the efficient frontier, the advantages of outsourcing can help Zara balance the current strategic trade-offs between cost, on the one hand, and flexibility, quality, speed, and responsiveness, on the other (Meixell and Gargeya, 2005). Outsourcing is an optimal solution to the trade-off because it can enable Zara to address multiple current contributors to its cost-related bottlenecks and inefficiencies without harming the other equally important strategic objectives (Cohen and Malik, 1997). One illustrative benefit of outsourcing for Zara is its solution to the high labour costs associated with its currently vertically integrated operations (Rao and Young, 1994). Zara’s competitors, Uniqlo and H&M, enjoy cost-related advantages over Zara because they have more than 80% of all their products manufactured by contractors in China and the broader Asian region (Hugos, 2020). The outsourced operations’ average labour costs of 0.80 Euros hourly are significantly lower than Zara’s average hourly wage of 11 Euros (Hugos, 2020). Notably, these costs are dramatically significant for Zara since it employs more than 3,000 personnel across European production operations (Inditex, 2022). Therefore, by replicating the outsourcing approach of its competitors, Zara can address high labour costs as a significant operations and SCM bottleneck through outsourcing. Implementing outsourcing optimises the current strategic trade-off in Zara's OM and SCM, pushing them toward the efficient frontier.

Outsourcing can also allow Zara to focus and improve its core competencies, reinforcing its competitive advantages. According to the framework of the decision logic of outsourcing, the recommendation for Zara to outsource will focus only on the OM and SCM activities that are not strategically important and do not involve specialised knowledge (Cohen and Malik, 1997). The decision to outsource allows Zara to delegate these non-core functions to specialised service providers, freeing the company to direct greater focus and resources to the firm's core business, strategic, and competitive advantage activities, generating enhanced effectiveness and efficiency in various areas, including the current problem area of cost control. For example, outsourcing allows Zara to enhance its valuable, inimitable, rare, and internally organised logistics infrastructure and competencies in route optimisation, advanced technologies, predictive analytics for enhanced inventory management, and greater supply chain visibility using blockchain.

Finally, the concept of order winners also supports the suggested outsourcing recommendation because implementing the suggestion would amplify Zara's current order winners. An order winner is a product attribute that, beyond qualifying the product for market participation, distinguishes it by making it the superior alternative to other market substitutes, rivals, and alternatives (Rao and Young, 1994). Based on the discussion regarding Zara's current SCM and OM strengths, Zara's order winners are quality, speed of delivery or lower lead times than competitors, and superior customer service overall. Addressing the current cost inefficiencies would allow Zara to amplify its order winners by introducing lower prices for even greater customer satisfaction. Allowing the company to specialise in its core competencies and competitive advantages can also support Zara in sustaining its current order winners.

Conclusion

This critical analysis has critically analysed Zara's OM and SCM, establishing that cost inefficiencies constitute the primary OM problem for Zara to resolve. The analysis recommended that Zara can solve this challenge by outsourcing the non-core elements of its current supply chain. Evaluating this recommendation using the concepts of the strategic trade-off and the efficient frontier in OM justifies the recommendation by demonstrating that the benefits from the recommendation push Zara's operations toward the efficient frontier. The decision logic of the outsourcing framework also supports the recommendation by indicating that it allows Zara to focus on its core competencies, thereby enhancing its order winners for greater competitive advantages. Therefore, the proposed recommendation is feasible and effective.

 

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