International Business Strategy of Zara - Case Study Example

Aim To demonstrate the effectiveness of Zara - the largest flagship in Inditex in accessing a supranational context in pursuit of the three goals of efficiency, flexibility and learning, by indicating the enterprise's overall strategy and the particular tactics it used in pursuing each and its comparative success in doing so. Introduction&Backgroud The Spanish fashion retailer, Zara is the leader in Europe, followed by the Swedish, H&M and UK's Marks & Spencers. Headquartered in the industrial estate of Sabon-Artexio, outside A Caruna in Spain, Zara has over 2700 stores round the world, the latest having opened in China, Serbia, Sweden and Tunisia in 2006 (Tokati, 2006) and in Poland, Romania and Russia in 2008 (Inditex 2008). Inditex SA, the holding company, clocked revenues of $8.5 billion in 2007, of which Zara contributed 66 percent (fibre2fashion). The expansion strategy positively contributed to the increase of Inditex's share value. The other fashion brands in Inditex's stable, Pull & Bear, Massimo Dutti, Bershka, Stradivarius and Oysho, though having the potential of cannibalizing some of Zara's advantage, are really no competition to Zara. Zara has stores in over 60 countries in Europe, America and Asia. However, the retailer has not gone whole hog in international expansion, particularly in the United States and Asia, because it has not expanded its supply chain wide enough to sell in these markets without holding high inventories. Instead, the company focuses on consolidation in the European markets, entering recently into Ireland, Iceland, the Czech Republic, Luxembourg, Finland and Italy and is expanding in England and Germany (allbusiness). Zara's business strategy is in contrast to most other apparel and other consumer product retailers in the world. While the other international apparel retailers such as Gap and H&M outsource over 90 percent of their production to low-cost centers in Asia and Latin America, Zara outsources only 60 percent and controls its entire production chain. Zara produces as many as 12,000 new items of clothing every year, which is nearly four times the average of the apparel industry. Besides, it replaces stock in 3 weeks, which is also 12 times faster than the industry average (Diaz, 2005). Zara's distinctive competence is consisted of vertical integration of design, just-in-time manufacturing system, delivery and sales; flexibility structures, low inventory, quick customization response and specific human capital (Castellano 1993; 2002). Amancio Ortega, founder of Inditex , claimed the aim of Zara is to " democratize fashion by offering the latest fashion in medium quality at affordable prices" This paper will discuss Zara's business model, particularly in relation to its supply chain and customization system, to understand whether its transnational business strategy is flexible, efficient and adapt to a learning process, which, according to Ghoshal's (1987) model, are the goals of a global firm. Theoretical Background The strategic tools that a global company has in order to gain competitive advantage are through exploitation of differences in input and output markets that exist in different markets. Besides, benefiting from economies of scale of operating in different markets and activities, global firms can gain competitive advantage that optimizes risks, efficiency and absorption of learning in different markets (Ghoshal, 1987) For some companies, global integration may result in competitive advantage through economies of scale. For some others, global expansion may not result in competitive advantage when the corporate hierarchy thrusts such a strategy on the company because of difficulties managing large organizations that blur centralized and decentralized policy decisions (Ghoshal, 1987). Since the second half of the 20th century, transnational companies have been the main agents of globalization in all industries, whether through investments, trade and the internet (Gereffi, 2001). In times of globalization, a firm's competitive strength in one market may not necessarily guarantee it succeed in another. Levitt (1983) postulated a global company essentially sells a standardized product and can "operates with resolute constancy . . . as if the entire world (or major regions of it) were a single entity", and distinguished multinational companies from that of the global companies, the former adapting to local tastes while the other carrying their standardized products, claiming that the latter is more typically the strategy of successful transnational companies. However, Hamel & Prahalad (1985) refutes Levitt's theory, defining global business strategy as a broad product portfolio with many product varieties but shared investment and technologies as opposed to the standardized product. In such a situation, cross-subsidization across products and markets may be necessary to gain competitive advantage in both. As Hout et al (1982) finds from a study of three global automobile companies - an American, a Japanese and an European - the success of the global strategist then is to arbitrage between products and markets through shifting of production between locations and multiple sourcing. Gereffi (2001) demonstrates that globalization of companies has occurred in three distinct phases. In the first phase (1950s to 1970s), globalization occurred in producer-driven markets like the automobiles through transnational investments in which production went global; in the second phase (1980s till 1995) in buyer-driven markets like commodities and consumer products through international trade when both production and sourcing was global and in the third phase (since 1995) through digital communication like in the case of computers when developments in telecommunication have enabled companies to get the maximum benefit out of technology. Porter and Millar (2001) showed that information technology has transformed the value chain by increasing efficiency and reinforcing each of the primary and secondary activities of the firm. IT system in Zara is vital for its lean chain. Simultaneous to the trend towards a global strategy, marketing strategies of companies have also moved towards market segmentation and customisation, thereby affecting the value chain even further by making it more flexible. In the age of technological innovation and creativity, marketing of consumer goods has shifted from mass production, the height of which was reached when Henry Ford introduced the assembly line in 1913, to mass customisation since the 1950s. This has led to the concept of market segmentation, which is clustering customers with similar preferences in segments and satisfying their needs through mass production (cited in Kaplan and Heinlein, 2006). Targeting the individual, rather than the mass as it was in the early days of manufacturing, standardization on the basis of customer segments has been the key to the success of many producers of consumer products, whether in automobiles, computers, home furnishing or apparel. Through E-customisation, that is, collaboration with the customer on matters of design and development of products on the digital platform, companies reap the benefit of information technology in order to make the strategy optimal. This allows the companies to gain from a learning process through the knowledge on customer's choice patterns. Mass-customised products incorporate market information on customers' preferences and tastes and hence are information-intensive products (Kaplan and Heinlein, 2006). Cohen and Levinthal (1990) note that a firm's absorptive capacity is a function to its prior knowledge. The development of absorptive knowledge of an organization is different from that of an individual and depends on the diversity of expertise within an organization. The absorption of knowledge based on information gathered from customers through direct and digital means is the key to product development of consumer products like apparel. Kogut and Zander (2003) finds from an empirical study that less codified the technology, the easier it is to transfer knowledge to the foreign subsidiary. Therefore, it is more difficult to transfer knowledge to subsidiaries for an apparel seller than it is for electronics and automobiles. Zara transnational strategy Zara's transnational business strategy is through internationalization inn stages, that is, first enter into similar markets before making its foray into more distant and dissimilar markets. The first Zara store was opened in 1975 in Spain. Through the 1980s, it expanded in the domestic market. The international expansion phase began in 1988 with a store in Portugal. Through the 1990s and in the present millennium, Zara has expanded its international market rapidly and in 2006, it operated in 52 countries with 852 stores, of which 664 were in Europe, including 259 in Spain, 112 in America, 45 in the Middle East and 35 in Asia (Lopez & Fan, n.d). There have been both push and pull factors for internationalization of Zara. The domestic market in Spain was not large enough to satisfy Zara's growth ambitions (push factor) and globalization, fragmentation of the European fashion market and the relaxation of apparel trading under the World Trade Organization (WTO) provided the push towards internationalization. In the process, Zara has used vertical integration to achieve fast turnaround times in stores, entered into franchise and joint ventures in new markets and used the store point of sale as the basis for customer information that is successively used for further product development. For branding, however, Zara does not emphasize on the country of origin but operates like a local company. Although till recently, Zara had a completely centralized operation structure, Zara has now begun to outsource some of the apparel manufacturing, with 12.5 percent of Zara's production being contributed by suppliers in China to reduce cost (Tokatli, 2006). Besides, design tends to reflect local culture elements and customer needs. However, Zara still keeps key resources and capabilities centralized, especially; it centralizes the inbound logistics, design and manufactory of fashionable items in the headquarters. Finally, sales control and accounting are decentralized to reduce the risk of exchange and coordination. Each subsidiary keeps high level of autonomy to determine how many and what kind and garments to order. Zara's Achievement of Efficiency Global companies achieve efficiency through the exploitation of differences in resource endowments across countries. In imperfect markets, firms compete with each other to earn "efficiency rents" by extracting surplus value from low costs of inputs and expanding value of outputs (Ghoshal, 2001). Most global companies operating in the low-differentiation products like electronics, benefit from transferring production facilities to low costs destinations. Dell Computers, an American company, for example, has capitalized on the cost differentials across countries by transferring its production entirely to Asia and Ireland (Achtemeyer, 2001). Other companies, however, achieve efficiency through exploitation of differences in national tastes and preferences. In the apparel retailing business, competitive advantage of global strategy addresses both integration (through cost differentials) and responsiveness (through taste differentials) parameters. Companies like H&M and M&S have expanded international business by lowering costs as well as expanding markets. Zara, on the other hand has focused its transnational strategy by responding to national tastes. It has refrained from outsourcing production to low cost destinations even though it has expanded international marketing. The headquarters in La Coruna monitor closely the production process, taking into account customer preferences on the basis of information provided from the store mangers who report daily on what is selling and what is not. The designers at Spain cut the fabric and send to the workshops and co-operatives in north Portugal and surrounding areas for sewing. The lines are completed in two weeks and shipped to the stores round the world. Even the international stores like those in the United States and Asia get the lines shipped from the headquarters in Spain. As a result of this close control of the production process, Zara is able to churn out about 11,000 designs every year (CNN, 2001). Zara's main strengths in the apparel retailing business are value for money as well as fast response to changes in customer tastes. The short lead times for reaching its products means that Zara stores can stock the most trendy apparel. Since it manufactures each style of product, there is usually a scarce supply, which induces higher demand for the line. Besides, it constant design upgrades means that it has more styles and choices and therefore a higher chance of selling right (Dutta, 2002). Thus, Zara has achieved efficiency though a counter-intuitive business strategy in which it does not target costs of production but volumes of sales, in other words, economies of scale. The company has concentrated on catching the newest fashion trends and beating the competition to it. By this, Zara is able to get the new fashion trends in 30 days while the general lead time in the industry is 4-12 months (Dutta, 2002). Flexibility The goal of achieving flexibility in the business process is to manage risks arising from operating in alternate markets that have different regulatory frameworks and tastes. Macroeconomic risks may be endemic to all companies, country-specific and across the borders. Policy risks, on the other hand, arise out of national policies in particular countries and may tend to be sticky. Often, macroeconomic and policy risks may be interactive and undifferentiable from each other. Competitive risks may also arise from local or global companies besides resource risks, including managerial risks. Overall, the strategic risks arise from the combination of all of these risks (Ghosal, 1997). Companies can either manage different kinds of risks arising from market or policy induced changes in comparative advantages of different countries, or balance scale with strategic and operational flexibility, or make portfolio diversification of risks and create options and side bets. Zara manages most of the above risks by innovating a global expansion strategy that is essentially a centralized one. The supply chain as well as the store logistics is controlled from its headquarters. Nearly 72 percent of Zara's sales are from international sales but over 40 percent is from non-Spain Europe (Inditex Annual Number, 2006). By thus operating mostly within the European Union, the company has been able to manage risks considerably since it can better predict macroeconomic and policy risks within the EU and adopt appropriate strategies. Besides, by adapting different suitable entry strategies, Zara can lower macroeconomic and policy risks. For example, in countries with high growth potential and low business such as most in European and South American, Zara opens own subsidiaries. While, it chooses franchising in high-risk countries where are culturally distant with Spanish, or have small markets with low sales forecast, such as Malyasia and Saudi Arabra (Flavian and Polo, 2000) Exchange rate risk arises on future commercial transactions, assets and liabilities recorded in foreign currencies and net investments in foreign businesses. Zara mainly chooses wholly owned subsidiary as its entry mode, it is exposed to exchange rate risk particularly from the US Dollar, the Mexican Peso, the Japanese Yen and the Pound Sterling. In order to control the exchange rate risk, Inditex uses forward exchange contracts, managing each currency's net position through external forward foreign currency contracts or other financial instruments. In addition, Zara has improved operational flexibility via global sourcing. One main point here is to reduce resource risks. Resource risks arise when there is uncertainty in the control of input, such as raw materials and labour. Through international expansion, Zara is able to adapt both backward and upward vertical integration world-wide to reduce resource risks. The resource risks are not only emphasised by Zara, but also by H & M, main competitor in the France, Italy, Poland, Portugal, Spain, and UK markets, and C&A main competitor in the France, Poland, Portugal and Spain markets. Unlike tightly vertical integration in Zara, H&M controls the safety and quality of the goods by extensive testing, while C&A by establishing a long-term, cooperative relationship with contract partners. Portfolio diversification of risks and creation of options are one reson of Zara's global expansion. When domestic market suffers recession, Zara could still increase revenue by flourish sales in the overseas markets. This also forms a main reason for Zara's global expansion. Announced by the former CEO of Zara, Jose Maria Castellano, the company's first expansion in 1989 is due to the saturation of the Spanish market. Therefore, Zara expanded to Portugal to pursue higher growth and to offset the sideway effects of domestic market reduction and maturity. Another one is brand portfolio. The inditex, the group that owns Zara brand, develops brands through a multi-brand strategy and an extension strategy. For example, the inditex not only created brands, such as Zara in 1975 and Pull & Bear in 1991, but also extended the existing brand 'Zara' to 'Zara Home'. The multi-brands portforlio has made risks previously only faced by Zara spread to other seven brands. Through its expansion in stages, Zara has grown to be flexible by selecting markets that allow it to take additional risk as its business profile matures. In the initial years of global expansion (1988-1996), the company added a few international stores, that gave it flexibility to try new but similar markets. Since the mid-1990s, the growing financial strength of the company has enabled it to take more risks and expand into dissimilar markets, which has entailed higher risks. The company has managed this risk through strategic flexibility, by positioning the brand as a local one while controlling the operations centrally. Besides, its business strategy of operating own subsidiaries in similar markets, where growth potential is high and risks are low, and entering into joint ventures and operating franchises in dissimilar markets where risks are high and growth potential is unpredictable or low, is also geared towards flexibility of operations. The risks are reduced considerably when the company associates with local companies through joint ventures in new markets. Learning A successful transnational corporation is supposed to simultaneously facilitate all four processes, that is, centre for global, local for local, local for global and global linked (Bartlett, Ghoshal & Beamish, 2008, p.457) to achieve the goal of worldwide learning and innovation. While the main impetus to globalization by companies is to expand sales, many companies also enter new markets to tap diverse capabilities arising from many stimuli and learning opportunities that would not be available to domestic firms. By developing the internal diversity in the knowledge base, the company would then be better equipped to cope with an unpredictable future. For example, P&G, an American firm, has set up a water treatment plant in Brussels because the mineral content in Europe is twice that in the USA (Ghoshal, 1997). However, the mere existence of the company in diverse markets does not guarantee it increased capabilities. It would then need to organize its internal resources and capabilities to further expand its knowledge base. Zara's market research is the most important of product development function of the company, making it an effective vehicle to understand customer preferences in various markets. The stores act as a sensor of the latest trends in the local markets. By collecting all the ideas from shops around the world, the design team in the headquarter choose the most valuable and profitable ones, which they think will satisfy all the consumers across regions; then these targeted designs are sent to the production sites in the East Europe, and finally the finished products reflected to the latest trends are distributed via the distribution centre to the subsidiaries in different countries. This mechanism meets both the locally leveraged and globally linked innovation models, and it helps Zara to achieve the goal of worldwide learning and innovation significantly. Although Zara's capacity to absorb learning on European markets is high, as is evident in the success of its business strategy, the same may not necessarily be applied in its transnational business strategy. Most multinational companies begin its transnational strategy in order to get access to diverse and larger markets but it necessitates enhanced organizational learning through diversity of learning experiences (Ghoshal, 2001) Very few companies can embark on the "innovation chain" that incorporates information transcending local clusters and national boundaries (Santos, Doz and Williamson, 2004). Zara has evaded this problem to some extent by choosing to expand its business in countries that are similar in business environments. Therefore, it has expanded mostly to European countries, and in the United States. Its expansion in Asia has been limited to Hong Kong, which market is somewhat similar to western markets. In order to increase its learning process in new markets, Zara first opens a flagship store in a new market to gather information about this market. With the acquired knowledge, it develops the market entry strategy into the new market more aggressively. However, this learning process may be unique for a particular market and may not necessarily be applicable in others. But it enlarges the knowledge base of the company that can be used in more new and related markets that have similar customer sizes and tastes, cultural parameters and local regulatory frameworks. Conclusion Zara is typically a European fashion retailer and has mostly concentrated on the European markets. It has also expanded to the United States, the Middle East and Asia but its main focus has remained on Europe. This is partly because of its small European supply chain and it ships to the stores in other continents from the headquarters and not directly from the vendors as other retailers do. Zara's transnational strategy has not taken advantage of the possibilities of outsourcing to low cost destinations as the others have but concentrated on producing at home and selling both at home and abroad. This has given it efficiency, though not so much in terms of labor efficiency, and flexibility in production, providing it the opportunities for adapting to learning of customer requirements. Zara's competitive strength in Europe, its investments in research and development and its absorptive capacity for innovation can be fruitfully used for the transnational business strategy that would entail incorporating new information from the local markets. Hence, rather than using customer information for mass segmentation of customers, the retailer would have to develop new products for the various markets, thus initiating an "innovation chain". For the purpose, it would be useful to develop separate supply chains for the various markets, for example use Mexico as a supply base for the United States and south east Asian countries like China and Taiwan for the Middle East and Asia. It can then utilize the high absorptive capacity for learning in the markets it operates in to expand into new markets. The company has made good use of information technology to track changes in customer tastes and to initiate a fast response in designing new apparel. The same organizational learning can be used in its transnational business strategy so that it can gain competitive advantage in other markets through an integration-responsive mechanism. 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