Critical Evaluation of the Strategic Viability of Zara - Case Study Example

Strategic management report: A critical evaluation of the strategic viability of Zara BY YOU YOUR SCHOOL INFO HERE HERE TABLE OF CONTENTS Analysis of key changes in strategic position 2. A critical evaluation of Zara’s responses 3. Analysis of competitive advantage 4. Recommendations for strategic improvement References Appendices EXECUTIVE SUMMARY Zara is a business that has achieved substantial revenue growth between 2000 and 2012. This growth has been achieved by expanding the business internationally at a very rapid pace, by having a competitive advantage of a two week lead time for fast fashion merchandise, and by controlling costs throughout the entire value chain. Zara owns most of its production and logistics/warehousing centres, giving its considerable ability to exert market bargaining power and control operational costs. Growth has also been achieved through diversification, such as Zara Home, a home decor business branded under the Zara name that offers unique household merchandise to new and existing consumer segments loyal to Zara. Zara has established strong brand recognition in international markets and considerable loyalty for offering limited quantities of fashion merchandise (clothing and accessories for exclusivity) and for quality. Diversification is the firm’s most appropriate, prescriptive strategic plan which illustrates ample planning and development for long-term competitive advantages. Based on the firm’s responses, both negative and positive, to external challenges, it is recommended that Zara consider using public relations strategy to promote its corporate social responsibility. As this strategy enhances brand reputation and Zara is adept in philanthropic activities and other socially responsible actions, using promotional communications to educate the ethical consumer about Zara’s CSR focus will give the firm greater long-term competitive advantage and a unique differentiation identity in existing and new international markets. A critical evaluation of the strategic viability of Zara 1. Analysis of key changes in strategic position Zara, with a growth rate of 37 percent, exceeded the growth rate of many companies in similar retail industries. With growth in revenue, global brand recognition, and better internal resources (e.g. human capital and economic capital), the company achieved growth through a horizontal diversification strategy. For Zara, there was no guarantee that the firm would continue to achieve growth solely through fashion retailing, especially with consistently-changing consumer behaviour patterns and global economic conditions. Horizontal diversification is a strategic concept whereby a firm offers unrelated products to new markets in conjunction with existing products, in this case fashion merchandise (David 2011). Diversification allowed Zara to reach new markets and capture the attention of existing markets once the firm had established a strong brand reputation and identity in international markets. Diversification was selected as a viable strategy for Zara based on several key criteria, including the competitive strength of the firm against established fashion industry players, trends associated with higher manufacturing costs, and realising that market penetration and market development would likely not achieve substantial growth; as recognised by Ansoff (1957) as criteria motivating diversification as a positive growth strategy. Zara had achieved competitive advantage in terms of keeping manufacturing costs low by having supply chain partners and other labourers associated with fashion merchandise production maintained in Asia. Prior to 2000, developing nations maintained favourable currency exchange rates and had significantly lower labour costs than in the domestic European economy. However, regulatory changes and wage improvements substantially contributed to higher procurement costs and other associated operational costs for fashion distribution. With a much higher cost factor for the firm, introduction of Zara Home, home decor products, Zara could capture new market attention and achieve higher revenue growth in an environment where the firm was witnessing much higher operational costs. Diversification, therefore, was an appropriate strategy to achieve growth. Diversification, exploiting economies of scale and other potent resources, is justified by growth in competition in key market environments. Main competition such as H&M, The Gap, Benetton and Fast Retailing represented considerable competitive rivalry in the fashion industry. According to Porter (1987), competitive rivalry is a significant threat to achieving strategic growth for a firm. H&M, as one example, has recruited such celebrities as David Beckham, Madonna and American singer Beyonce to promote and endorse male undergarments, swimsuits and innovative fashion collections. The research literature indicates that famous persons’ endorsements strongly influence consumption decision-making (Pornpitakpan 2003) and builds strong emotional attachments to a brand as well as trust as perceived by the consumer (Kim, et al. 2014). Recruitment of such high profile celebrities in promotional strategy is a highly expensive activity in the marketing function. It has been reported that David Beckham commands $50,000 USD each day during involvement in promotion (Kandlur 2014). Singer Beyonce commanded $50 million USD for a multi-year contract with the Pepsi Company (Said 2013). These are substantial expenditures for using celebrities as the relevant marketing strategy at H&M. However, these are highly effective promotional expenditures for a firm as aspirational celebrity imagery and endorsements improve brand recall and give many consumer segments higher favourability toward the firm’s products (Clark and Horstman 2003). At the time, Zara was not in a position to recruit dynamic and expensive celebrities in order to achieve growth. Before introducing Zara Home, Zara was witnessing H&M and The Gap achieving significantly higher revenues than the firm, as illustrated in Figure 1. Figure 1: Revenue outperformance by Zara competition – 2000 to 2003. Fashion Retailer Year Revenues (in millions) H&M 2000 $4,308 Gap Inc. 2000 $13,673 Inditex 2000 $2,402 Source: Caro, F. (2011). Zara: staying fresh and fast, UCLA Anderson School of Management. In terms of resources, in the year 2001, at the time of the firm’s IPO, the stock was valued at approximately €3.80 (Bloomberg Business 2015). This low valuation made significant capital procurement difficult, as in 2000, the firm had invested millions of Spanish Pesetas to expand the business, opening 150 new international retail stores and building ground-up distribution centres and production centres (Inditex 2000). With revenues much lower than competition, new debt for expansion, low capital capability with a low stock valuation in 2000, and limited experience in product development, diversifying the firm was appropriate and viable to ensure higher revenue growth. In 2003, Zara Home provided Inditex with additional revenue growth of 10.6 million Euros (Inditex 2004). By 2006, Zara Home encompassed 35.4 percent of total international sales for Inditex and had achieved a 78 percent growth rate (Inditex 2006). Diversification was relevant for Inditex as the firm maintained internal competencies operating in foreign markets, having established retail outlets in Portugal, Japan, Istanbul, the United States and Korea by 1988. This is fundamentally important for a learning-focused organisation seeking market expansion and growth (George 2014; Inkpen 2000). Between 1988 and 2003, at the time of the diversification strategy launch of Zara Home, the firm had gleaned considerable management competencies working with diverse consumer demographics around the world and gaining an understanding of the different socio-political dynamics that impact a firm at the macro-economic level. Diversification, as a change in strategic tactics based on external market conditions, was appropriate for ensuring continued growth in a fashion industry with an uncertain life cycle and diversification laid the foundation for future long-term growth through launching new, unrelated products in different or existing markets. Success in Zara Home has given the firm experience in diversification management, with its subsidiary Stradivarius launching its own cosmetic line in 2014 (FMag 2014). This requires new supply chain methodologies, production centre development, and branding strategies in order to make diverse product lines sell in key, potentially profitable markets. Zara Home gave the firm substantial competencies along the entire value chain for operating and selling products in a contemporary global environment, hence making future diversification viable for Zara. This likely underpins Inditex’s explosive revenue growth after 2006 (Caro 2011). Zara also maintains the ability to be a low-cost provider by controlling costs, when possible, throughout the entire value chain (Grant 2002). By ensuring that the majority of its production and design centres are wholly-owned, this gives Zara much more bargaining power along the supply chain, another advantage identified by Porter (1987). This impacts the ability to provide consumers with reasonably priced fashion merchandise. Concurrently, with wholly-owned production centres, Zara can provide consumers with a two week lead time on new product replenishment, thereby differentiating in terms of merchandise selection and variety. This is a form of competitive edge for Zara in an industry where other major competitors must rely on foreign production labour that significantly increases lead times and replenishment capabilities for relevant fashion products. 2. A critical evaluation of Zara’s responses Zara’s responses to external challenges were prescriptive in nature, whereby objectives are pre-formulated and well-developed before the strategy is implemented (Johnson, Scholes and Whittington 2009). Zara realised that the fashion industry maintains an uncertain life cycle and that much of what is being produced and distributed is highly dependent on consumer attitude and behaviour, both social and psychological. Ferdows, Lewis and Machuca (2003) assert that Zara gains market success by creating an identity of exclusivity by only providing a few key pieces of similar merchandise for the discriminating consumer demographic. Whilst this strategy aids in building a positive brand image for Zara, it is not a guarantee of success. With major competition using celebrity-based promotions to gain more consumer attention, it is not unreasonable to consider that Zara might face future competitive threats by companies with ample management resources and financial resources that can begin emulating this fast fashion, exclusive business model in fashion clothing and accessories. Nandan (2005) states that in an environment with this threat, the only real asset the firm maintains is its brand. Hence, the sustainability of this model, in terms of life cycle, was uncertain at the time that Zara determined that diversification was the most appropriate growth strategy. Coupled with an established strategy that did not place considerable financial resource allocation toward advertising, the strategy of a superior in-store experience must not achieve growth in the long-term. Hence, achieving growth through diversification allowed the firm to build on its strong brand recognition and high levels of trust that Zara had achieved from the 1980s through 2001, a positive response to an environment with changing consumer behaviours. Coupled with higher import/export taxes and improving workers’ rights and child labour laws in Asia (Suttle 2011), Zara faced considerable market uncertainty that injected considerable risk into the business model if the firm had focused solely on attempting to extend the life cycle of simply fashion merchandise. Zara, by differentiating through more rapid replenishment strategies and offering exclusive merchandise, had established the foundation of brand loyalty by the mid-2000s. This loyalty is established once the brand has achieved a positive reputation for service competency, quality, economic value to consumers, and social value (Deng, et al. 2010). This had been accomplished by the in-store experience, quality of materials procured, exclusivity with social ramifications, and pricing affordability. Therefore, Zara made the right decision for development of a long-term, prescriptive diversification strategy that has served the business well since 2003. By this point, Zara had also established a cohesive and compliance-based culture, known as an all or nothing culture, which is focused on performance and productivity (Capell 2008). Hence, change and compliance to new productivity expectations was a regular aspect of Zara’s business model that promoted employee/management diligence in surpassing competition. Diversification requires new value chain activities and new methods of conducting operations. Therefore, in an environment with long-run risks associated with competitive rivalry, changing consumer attitudes and consumption behaviours, and rising costs of fashion production, diversifying to wholly-different offerings prepared the business to achieve long-term growth success in the event of uncertainties in the fashion industry. Furthermore, using the cost-of-entry test, Zara already maintained a market presence in many countries offering Zara Home and cosmetic products, hence entry was less burdensome in terms of cost and therefore represented a quality long-term strategy without straining the firm’s capital budgets. Rather than waiting for emergent market conditions to dictate strategy development, the firm was proactive in ensuring it could achieve international growth in the event that market conditions deteriorated and growth became stagnant in the fashion industry. However, with diversification and a need to distribute wholly-new products, the firm was a bit lax in determining a new logistic strategy. All of the firm’s logistic centres and warehouses are in Spain (Caro 2011). Zara Home products are distributed in France, the UK, the Middle East, the United States, Costa Rica and in Asia (Inditex 2011). By 2012, Zara Home had established a 40 percent Return on Capital Employed (Inditex 2011), which represents the firm’s earnings based on the total capital expended to sustain operations of a business division. Zara Home’s return on capital employed was even higher than Zara, itself, in 2011 by eight percent (Inditex 2011). Concurrently, Zara maintained little debt financing by 2011 and 2012 and was considered the most valuable business in Spain. Hence, achieving financing for creating a more centrally-located logistics and warehousing centre in Asia would significantly reduce the costs of distributing products in this region. For instance, the exchange rate of the Chinese is highly favourable for establishing such a centre on this continent. Each Euro is currently worth 6.78 Chinese Yuan. A €30 million investment for a new centre in China (or other centrally located region), would only cost approximately €4.4 million (Euros) in this country. This is well within the resource capacity of Inditex and would allow the firm to better control pricing along the supply chain for its diversified business units (e.g. Zara Home and cosmetics). Zara was not proactive with a prescriptive strategy for diversifying the fashion business and, instead, continues to move product from Europe which is regulated with taxations by the European Union in the host currency. An earlier construction of the logistics and warehousing centre/s in Asia would have provided opportunities to utilise lower-cost Chinese domestic procurement of Zara Home products and reduce some operational and overhead costs to expand the Zara Home concept. Emergent market conditions post-2010 indicated Zara Home would be profitable in new markets and it does not appear that Zara brand leadership fully recognised its long-term profit opportunities and created a new logistics strategy for cost controls to service these Asian markets. 3. Analysis of competitive advantage Zara maintains two distinct competitive advantages: high bargaining power in its operating markets and a fast fashion model that gives the firm more brand power. As aforementioned, cost leadership under Porter’s Generic Strategies for competitive advantage allow the firm to exploit its economies of scale, spread its fixed costs over more units, and direct ownership of its production and logistics-based operations allow it to better service the price-sensitive markets attracted to the pricing structure of Zara’s products (Wright 1987). Since the 1990s, Zara has proactively created and/or acquired new subsidiaries to manage its diverse portfolio of products under the Zara brand, such as Zara Home and Stradivarius; another dynamic of prescriptive strategy. By having more control over supply chain pricing from vendors, controlling lead times for raw materials, and having direct control over production in key product areas, the business can offer affordable merchandise that provides ample competitive threats to major players in the industry. The fast fashion model as a competitive advantage is supported by a culture of productivity and compliance. Concurrently, by keeping inventory levels low and offering new fashions at a much higher rate than competition, Zara customers revisit the store 17 times a year instead of the industry average of three visits annually (CNN 2001). Zara controls not only procurement, but distribution of raw materials, the entire design process from start to finish, and the tangible manufacture of finished product (CNN). H&M and the Gap have lead times from start to finish distribution of up to nine months. Gallaugher (2008) asserts that Zara’s market power is so substantial, that many cooperatives involved in the production process do not even mandate signing contractual partnership agreements. Coupled with the ability to sell its own fashion commodities in its own store, this impacts pricing structures, making the clothing more favourable to consumers without having the routine retail mark-up associated with reliance on secondary retailer channels to sell its products. These competitive advantages have only strengthened between 2003 (the time of the launch of Zara Home) and 2012. With more stores under the firm’s rapid expansion strategy now maintaining presence in many foreign nations, having partnership agreements for supplying raw materials or being involved in the manufacturing process is a lucrative opportunity for other businesses around the world. Zara maintains a gross profit margin of 59 percent as of 2011 and 2012 (Sulisetiasih, Junardy and Adam 2013), which is much higher than industry average in this fashion category. Gross margin is the selling price of units less the cost of goods sold. Hence, Zara is able to control costs efficiently, under its cost leadership ideology, to ensure maximisation of profit per unit of fashion (and home decor) merchandise sold. 4. Recommendations for strategic improvement Whilst the case study of Zara iterates that in response to changing market sentiment the firm has created more positive corporate social responsibility policies, the firm can capitalise better on these competencies to give the brand more trust and loyalty. There is a growing trend in a phenomenon known as ethical consumption, or the propensity of consumers to make recurring purchases with companies that promote a strong ethical and moral stance (Oh and Yoon 2014; Grande 2007). Zara does not appear to be utilising opportunities to use CSR and its ethical values as a promotional tool that would gain the interest of consumers sharing a propensity for ethical consumption behaviour. Nandan (2005) asserted that the only real asset a firm maintains is its brand identity and brand reputation. Inditex has been working on reducing its carbon footprint, has signed fair labour standards agreements, and launched a campaign to plant trees. However, Sarvaes and Tamayo (2013) iterate that when consumers receive education about a firm’s CSR achievements, it translates into a symbol of quality related to the firm’s products over that of competition. Hence, there are opportunities for the firm to utilise public relations marketing, a low cost activity, in order to give consumers a view that Zara maintains the utmost values related to philanthropy and improving social well-being. Public relations identify relevant public attitudes and expectations and then a firm executes a plan to gain public followership and acceptance of the firm’s commitment to the public interest (Wilcox, et al. 2003). This takes the form of press releases, social media, advertisements, or any other communication forum to spread information and knowledge about a firm’s ethical tactics and ideologies. A second potential strategy is for Zara to consider a product development strategy for growth, creating consistently innovative products for launch into existing markets. Through joint ventures or acquisition of rights to produce another firm’s products, Zara can expand its brand to include a much broader portfolio of products. For instance, Zara can begin offering specialty gift baskets targeted at diverse consumer demographics, offering such products as men’s grooming, women’s fragrances and care packages, or specialty themed products available for sale in Zara stores. For example, if Zara began offering organic skin care products, there are tremendous opportunities. It is a market worth $7.6 billion USD as of 2012 and is expected to achieve a growth rate of nearly 10 percent by 2018 (Patterson 2015; Pitman 2013). Zara already maintains internal expertise in the beauty and personal care industry with the launch of a cosmetics line and already engages in online retailing which could facilitate home delivery of Zara-branded personal care specialty baskets. However, this strategy would require a completely different supply chain development, consisting of organic product retailers, gaining certifications to sell these organic products based on EU organic retailing regulations, and would require more investment in promotion in order to engage consumers with these new products. It would also require multiple promotional scheme developments to appeal to the socio-psychological characteristics of diverse organic consumers, which would raise costs of marketing under a model that wishes to reduce these costs. Whilst such gift baskets were once a niche market, but now mainstream, the value of home delivery of these products is still estimated at only (approximately) £216 million annually (Statista 2015). Hence, the most viability strategic option for Zara is to utilise public relations strategy to gain more consumer trust and loyalty in the brand by promoting its CSR focus using appropriate and contemporary channels for communication. These activities are low-cost and require more collaboration with media representatives/agencies and devoting more in-house labour toward development of a real-time social media communications strategy. Around the world, social media is being utilised by many demographics of consumers as more developing and developed nations offer options for Internet access. These forums provide opportunities for a firm to communicate with its mot desirable target market, facilitating two-way discussion, and enhance relationship development with consumers. By using low-cost PR strategies to educate consumers about Zara’s CSR activities, it will gain more interest and attention from consumers that make decisions based on ethics and morality of a firm. Oh and Yoon (2014) reinforced that ethical consumption is changing the mindset of corporate leaders toward being more responsible and seeking strategies to promote this. Hence, it would only require Zara to develop a social media presence, hire appropriate staff to manage these real-time communications, and develop various promotional literature and imagery to iterate how Zara is making a difference worldwide. For a rather small operational expenditure, the potential for pay-off as a new form of competitive edge are rather substantial. Firms that do actively and regularly promote their CSR objectives and achievement achieve between eight and 10 percent sales increases over ethical firms that do not use PR to educate on CSR (Harrison and Shaw 2005). The long-run advantage of this strategy is better brand reputation and capturing a growing segment of consumers willing to chastise firms without CSR focus in favour of more ethically-minded businesses. Figure 2: Carbon Footprint Reduction Statistics for Zara Between 2006 and 2010, the company reduced its carbon emissions by 200 million tonnes (Caro 2011). It costs little to publish these successes, with elongated stories about how and why Zara has achieved these goals. It is low expenditure, high return on investment strategy for a company that has already established trust in its brand and a new opportunity to capture even more diverse ethically-motivated consumer segments throughout the world. References Ansoff, I. (1957). Strategies for diversification, Harvard Business Review, 35(5), pp.113-123. Bloomberg Business. (2015). Inditex (ITX: Continuous Market SIBE). [online] Available at: http://www.bloomberg.com/research/stocks/charts/charts.asp?ticker=ITX:SM (accessed 18 April 2015). Capell, K. (2008). Zara thrives by breaking all the rules, Bloomberg Businessweek Magazine. 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Pornpitakpan, C. (2003). Validation of the celebrity endorsers’ credibility scale: evidence from Asians, Journal of Marketing Management, 19, pp.179-194. Porter, M.E. (1987), From competitive advantage to corporate strategy, Harvard Business Review, 65(3), pp.43-59. Said, S. (2013). The most expensive celebrity endorsements, The Richest. [online] Available at: http://www.therichest.com/luxury/most-expensive/the-most-expensive-celebrity-endorsements/ (accessed 19 April 2015). Servaes, H. and Tamayo, A. (2013). The impact of corporate social responsibility on firm value: the role of customer awareness, Management Science, 59(5), pp.1045-1061. Statista. (2015). Value of organic market sales in the United Kingdom from 2011 to 2014, by retail channel. [online] Available at: http://www.statista.com/statistics/300073/organic-retail-market-value-in-the-united-kingdom-uk-by-channel/ (accessed 16 April 2015). Sulisetiasih, A., Junardy, K.W. and Adam, P.M.A. (2013). Strategic management: Zara, University of Indonesia. [online] Available at: http://www.academia.edu/5492552/The_Strategic_Management_Analysis_of_ZARA_Relative_to_the_Case_in_Developing_Countries_ (accessed 18 April 2015). Suttle, R. (2011). The macro-environmental factors affecting the clothing industry. [online] Available at: http://smallbusiness.chron.com/macroenvironmental--‐ factors--‐affecting--‐clothing--‐industry--‐37254.html (accessed 18 April 2015). Wilcox, D., Cameron, G., Ault, P. and Agee, W. (2003). Public relations: strategies and tactics. New York: Pearson Education. Wright, P. (1987). A refinement of Porter’s strategies, Strategic Management Journal, 8, pp.91-100. Appendix A: All Potential Micro-level Threats to Zara under Porter’s Five Forces Model Source: Rice, J.F. (2010). Adaptation of Porter’s Five Forces Model to risk management, Defence Acquisition University. [online] Available at: http://www.dau.mil/pubscats/PubsCats/AR%20Journal/arj55/Rice_55.pdf (accessed 18 April 2015). Zara is also impacted by threat of new entrants (though minimal due to high entry costs), bargaining power of buyers, and threat of substitutes in international markets. Zara maintains more bargaining power than its B2B customers achieved through exploitation of its economies of scale and considerable market capitalisation. Appendix B: Store Growth Statistics for Zara Between 1997 and 2011, Zara went from presence in only 13 countries to 110 countries. This is rather unprecedented in fashion industry history. Source: The Economist. (2012). Fashion forward: Zara, Spain’s most successful brand, is trying to go global. http://www.economist.com/node/21551063 (accessed 17 April 2015). Read More