Zara’s parent company Inditex has created one the best business model in apparel and over the last few years has regularly delivered double-digit earnings growth.
In this article I attempt to deconstruct Zara’s business model into its main parts:
Who is the customer?
Zara’s target market is young, price-conscious, and highly sensitive to the latest fashion trends. They have an advantage over traditional retailers because they do not define their target by segmenting ages and lifestyles giving them a much broader market.
They segment their product line by women’s (60%), men’s (25%) and the fast growing children’s (15%) department.
Zara started operations in Spain in 1975, and now operates in 74 countries worldwide.
What is the value proposition?
Fashionable, affordable clothes
Zara’s strategy is to offer cutting edge fashion at affordable prices by following fashion and identifying which styles are “hot”, and quickly getting the latest styles into stores. They can move from identifying a trend to having clothes ready for sale within 30 days (where as most retailers take 4-12 months). This is made possible by controlling almost the whole garment supply chain from design to retail.
Large choice of styles
Zara produces around 12,000 styles per year (compared to the retail average of 3,000), which means that fresh fashion trends reach the stores quickly. A typical Zara’s customer visits the store 17 times a year compared to the average of 3 times per year. This high number of styles also means that the commercial teams have more chances to find a winning style.
By reducing the manufactured quantity of each style, Zara creates artificial scarcity and lowers the risk of having stock it cannot sell.
Scarcity in fashion increases desirability, which means shoppers need to buy quickly as the item may not be available next week.
Lower quantities also mean there are not much to be disposed when the season ends; Zara only discounts 18% of its stock in sales, which is half the industry average.
Zara spends relatively little on advertising (0.3% of revenue) compared with traditional retailers (3-5%), instead they reach their target market by locating their stores in prime town-centre locations.
How do they deliver it?
Most retailers outsource production to low-cost Asian countries. In contrast Zara is vertically integrated with the majority of production carried out in owned or closely controlled facilities in Spain. This gives a lot more flexibility and speed however it means higher costs.
Stores place orders twice per week and the supply of finished goods is matched to store demand. Production is then increased or decreased in the flexible production facilities. Demand based production means there is very little inventory in Zara’s supply chain, which results in much lower working capital requirements.
Deliveries typically arrive one to two days after ordering with most deliveries arriving by truck from the Spanish factories. Clothes are then put straight onto the sales floor and are available to purchase.
Business model risks
Just-in-time manufacturing relies heavily on production in Northern Spain. Any weather, labour or terrorist disruption to the area will have a serious impact to sales, as there are no alternative supply centres in Europe.
As production is carried out in Spain where average wages are higher than low-cost Asian countries so factory wage costs will be higher than competitors, which will affect margins.
Zara is also vulnerable to financial vulnerabilities in the Euro as most of its cost-base is denominated in Euros.
Finally increased oil prices will affect profits as twice-weekly deliveries means higher transportation costs.