Strategic Management Accounting at Inditex - Essay Example

Strategic management accounting Table of Contents Inditex 3 Business Model interaction with the product market 3 Product market 5 BCG Matrix of Inditex 6 Porter’s Five Forces 7 Product Life Cycle of Inditex 9 Introduction 9 Growth 9 Maturity 10 Decline 10 Capital Structure 13 Capital market of Inditex 14 Internal architecture 18 Interaction between the product and capital market 19 Nexus of contract 19 Financial analysis 19 Leasing and Off balance sheet 20 ROCE 22 Conclusion 24 Reference List 26 Bibliography 28 Inditex Inditex (Industria de Diseno Textil, S.A.) is regarded as one of the largest fashion retailer in the world, which owns 8 brands (Inditex, 2015a). The company is headquartered in Galicia. It not only sells clothes but also deals with the activities such as production, distribution and textile designs. The founder, Amanico Ortega is regarded as the richest man in Spain and third richest in world. The company operates globally through a number of stores amounting to about 6460 (Inditex, 2015a). Business Model interaction with the product market The business model of Inditex is unique, which is described henceforth. Figure 1: Business Model (Source: Inditex, 2015b) The business model consists of four elements: manufacturing, logistics, stores and design. These elements are briefly elaborated henceforth (Inditex, 2015b). Design The clothes are changed twice a week with new models and designs so that the customers keep on visiting the stores quite often in search of new designs. The most interesting part of the business model of the company is that it has different set of collections for northern and southern hemisphere. Hence, they cater the exact needs of the customers living in different parts of the world (Inditex, 2015b). Manufacturing The company maintains a good relationship with the suppliers and they are situated at a near proximately from the production grounds. Inditex has the ability to react to changing demand of customers over period of time or seasons. It also follows the ethical means of producing clothes; maintains high quality, security standard, labour regulations and produce models by following sustainable methods of production (Inditex, 2015b). Logistics The models are despatched to the stores situated in different parts of the world and the process is repeated twice a week. The company incorporates the environmental standards for saving energy while delivering the products to the stores. The Pro Kioto Inditex is an eco-friendly logistics centre, which provides information pertaining to logistics of the company. Inditex have also undertaken Terra projects that aim at reducing emission of carbon dioxide (Inditex, 2015b). Stores The stores of Inditex are constructed according to the Inditex Eco-efficient Stores manual; it provides technical instructions for the electrical installations, plumbing, HVAC, lighting, waste installation and furniture. The manual also instructed to take measures pertaining to reduction of waste during the production process and to reuse the wastes that are generated during the phase of manufacturing. Customers Lastly, Inditex had successfully identified the needs of its customers worldwide and satisfied them over the years of operation since its inception. Product market The business model of Inditex aims at serving its customers particularly with respect products. The main attraction of its business model is that it changes the design of the clothes twice a week; this strategy makes the customers to visit the stores quite often to check the new collections. It places more than 900 million garments in the global market every year (Inditex, 2015c). The quality of this garments are non-negotiable. The products comply with the safety standards and also maintain the in-house health (Inditex, 2015c). The exclusive brand of Inditex, Zara needed a prominent shop window so that it can go global. During 15th March, 2012, the brand opened a huge shop outlet in Manhatten, which costs $324 million. The main reason for opening the shop was to show the New Yorkers that Zara is present everywhere. However, Zara struggled in America as outside the city the customer’s preferred long outfit whereas Zara produced short and slim fit clothes; In China, the clothes of Zara are far priced than the local competitors; it is much cheaper in Europe. Before entering a particular country, Inditex has to consider the business model, taste and preferences of that place. Hence the cost of the company increased due to its global journey (Ferdows, Lewis and Machuca, 2004). Figure 2: Zara Soars (Source: The Economist Newspaper Limited, 2015) Zara went global by opening stores in different parts of the world, which not only gave them good revenue but also helped the company to gain prominence in the world market with its designer products. The company has strong demand for the clothes that are manufactured and distributed to different stores around the world. The cost structure of the company is suitable for the market in which the company operates. Though the company sells the products at a premium prices but its demand has never decreased as it provides the customers with new designs. BCG Matrix of Inditex BCG Matrix aims at portraying the difference that exists between the relative market position and growth rate in the industry. Star (High market growth and high market share) Inditex Question Marks( Low market share and high market growth) Pull&Bear Cash Cows (High market share and low market growth) Dogs (Low market share and low market growth) From the above table, it can be identified that Inditex is placed to be Star as it own the highest market share globally and also compete in such an industry which has higher growth rate. However, its brands such as Pull&Bear and Bershka is identified to be Question Marks as they does not have high market share as compared to its fellow brands under Inditex such as Zara (Telegraph Media Group Limited, 2015). The company undertakes horizontal and backward integration strategies, market development, market penetration and product development strategies. The most important brand of Inditex is observed to be Zara and the company makes specific investment for the development of the brand (Telegraph Media Group Limited, 2015). Inditex has experienced increase in profit during 2014 by 22% as compared to 2012 (BBC, 2015); the increase was marked by the rise in sales revenue in Eastern Europe and in the new stores of China. It is observed the Inditex has captured about 14% of the domestic market (Spain); its market share in Spain is lower by 1% as compared to other markets in the US and China (BBC, 2015). However, there is room for improvement in the near future. Moreover, it is noticed that the company has been disappointed by the decreasing sales in Europe and the UK and predicts that the company will gain momentum again in 2015 (BBC, 2015). Porter’s Five Forces Threat of new entrants There are high barriers for the new entrants in this industry due to the size of the competitors, establishing brand, resources and networks. The threats of new entrants are also dependent on the present state of the economy. Threat of substitutes The product portfolio of Inditex stretches from gadgets to clothing and sells almost everything that is present in the fashion industry. Therefore, the threat for substitute in the industry is nil as the competitors are engaged in providing the same type of products to the market. Bargaining power of the buyers The retail chains of Inditex are price leaders in Spain, which creates a competitive advantage for the company against the local competitors ((Inditex, 2015b). If the prices of the products are high in Inditex the customers can switch to other retailers for their necessities. Therefore, it can be stated that the bargaining power of the customers are high. The company can lose its market share internationally as there are low-cost apparel retailers. Bargaining power of the suppliers The bargaining power of the suppliers is limited as the company owns significant number of suppliers for strengthening its bargaining position in the industry. Industry rivalry Inditex has achieved its competitive advantage through effective control in supply chain, high fashion and implementing right pricing strategy. However, there are few competitors of the company such as Mango MNG Holding, Benetton Group SPA and H& M Hennes & Mauritz AB. Product Life Cycle of Inditex The product life cycle of Inditex is briefed henceforth with the help of the diagram. Figure 3: Product Life Cycle (Source: (Zhelyazkov, n.d.) Introduction The company was introduced in 1963 with the aim of serving the customers with high quality products, with premium prices. Initially the company used to sell clothes by outsourcing them but soon it became the manufacturer of its brands. During 1975, the company opened its first Zara store in LaCoruna in Spain after experiencing 12 years of introduction phase. The company generated considerable sales revenue since its inception. The fashion approach of Zara was preferred by the mass in Spain, which have encouraged the company to extend the number of new stores in Spain. Growth Inditex was incorporated as a holding company and it also established a distribution system, which is capable of shifting the market trends very quickly. Zara further extended the number of stores to Portugal and welcomed its first US customers to the new stores in the New York. Inditex also entered France with its established stores in Paris. The brands such as Massimo Dutti and Pull&Bear were incorporated into the company. The company has continued to expand in all geographic directions and then opened a new store on Mexico. Slowly the company penetrated into Greece, Sweden and Belgium. During 1997, the footprints of the company further reached Israel and Norway. Maturity Inditex was in a maturity stage during 2000 when its headquartered was shifted to a new building in the Arteixo and the company began share trading in 2001. Thereafter, the company had experienced immense growth in sales revenue and profit over the years. Decline Despite the growth in sales revenue of the company, it has experienced challenges pertaining to different course of actions. The decline stage of Inditex indicated those years, when the company has encountered huge drop down in the profit figure, which was particularly during 2013-2014. During this time, the operating expense increased to a great extent as new stores of Zara was opened and was renovated. The following figure indicates the sales revenue of the company for the past five years: Figure 4: Sales revenue of Inditex for four years (Source: Author’s creation) In the figure provided above, it is observed that the sales revenue of the company has increased to a great extent over the period of time from 2011-2014. The company has gained a strong sales position in that period of time, which indicates that the customers have preferred the brands over its competitors. The following figure highlights the comparison of the sales figure between Inditex and its competitor: Figure 5: Sales revenue of LVMH Vs Inditex (Source: Author’s creation) From the above figure it is evident that the sales revenue in LVMH is higher as compared to Inditex. Hence, LVMH is in a stronger position that Inditex. Figure 6: Actual Vs Margin of Inditex and LVMH (Source: Author’s creation) From the above figure it is evident that the profit margin of Inditex is lower than that of LVMH mainly due to its universal presence. LVMH is a premium brand and sells the product at higher profit margin and the prices are also very high; however the demand for the same is also very high. On the other hand, Inditex manufactures limited designs and delivers it to the stores twice a week. Hence, the volume is low as compared to the sales volume of LVMH. Capital Structure Modigliani-Miller (MM) Theory states that the value of a company in the market is based on its earnings and the risks attached with the assets. It is independent of choice of source of finance and distribution of dividends. Hence, a company can choose from the mentioned two methods such as debt and equity. Hence, the theory aims at describing the main source of finance for a company (Modigliani and Miller, 1958). Moreover, the capital structure of a company defines its capital investment in the business, which generally includes debt and equity. The debt comprises the loans and different types of credits that are required to be repaid in near future along with interest. Moreover, equity involves sale of shares under the interest of the company, particularly in the name of stock. The capital structure of Inditex is briefed henceforth. Capital structure of Inditex   2013 2012 Debt 4654 6743 Equity 9278363 8481861 The majority of the capital structure of Inditex contains equity investment rather than debt obligations. This denotes that the company does not rely on the debt obligations too much rather the shareholder’s are content with the returns offered to them; this has encouraged them to invest in the company share over the years. From the table provided above it can be stated that the company has concentrated on decreasing its debt obligation during the past two years and the equity holdings has increased. This is referred as the conservative financing policy, which does not add risk factor to the company. Capital market of Inditex Inditex trades its shares in Spanish Stock Exchange through Continuous Market. The company has market capitalisation of 80.57 billion € as of December 2014. The following figure highlights the fluctuations in the share price that have occurred due to the variations in the sales revenue and profit of the company over five years. Figure 7: Share price movement of Inditex over 5 years (Source: Inditex, 2015d) The above figure indicates that Inditex have concentrated on increasing its share price over the years from 2011 to 2014. It has maintained a steady growth; however, during the third quarter of 2014, the company experienced first decline in profit, which affected the overall financial performance. The decrease of the profit was due to the increase in expenses of the company. It is noteworthy to mention that Inditex has experienced rise in sales by 3.4% (Guardian News and Media Limited, 2014). It failed to generate profit for the year as the sales distribution expense rose by 7.2% as one of its brand; Zara, renovated three large stores in the Manchester and London and even build ten small branches. However, Inditex revived from the situation during the first quarter of 2015 as it concentrated on decreasing the operating expenses and increasing profit margin (Guardian News and Media Limited, 2014). Figure 8: IBEX VS Inditex (Source: Author’s creation) The share price movement of Inditex is compare with that of IBEX, which is the stock market Index of Spain. The figure shows that the performance of Spanish stock exchange is stronger than that of Inditex. Random Walk Theory Random Walk Theory states that the stock price keeps on changing at a same distribution level and also independent of the effects that occurs due to the changes. The past movements cannot be employed in order to predict the future performance. Hence, the stock usually takes an unpredictable and random path (Van Horne and Parker, 1967). The stock price of Inditex is observed to have followed random walk for the past five years as described in Figure 4. Stock Split During 11th June, 2014, Inditex had announced stock split at a ratio of 1:5. People and technology The company follows flat organisational structure, which does not have any hierarchy and thus it aims at facilitating easy exchange of opinions and idea throughout the company. For promoting the working environment, the company has developed Internal Code of Conduct, which is popular among the employee (Vincent, Kantor and Geller, 2013). Inditex was chosen as the best company to work in Spain by Merco (Corporate Reputation Business Monitor). The decision was taken from the opinions of students, professionals and business people (Pidelaserra, 2014). Inditex follows a decentralised decision making system, where it communicates the decisions to the managers of each brands such as Zara. Henceforth, Zara operates in a centralised manner as it addresses its employees and staffs with the actual decisions that are communicated from parent company, Inditex. The people are highly motivated in the company and this is reflected in its HR policy. The company aims ate hiring young talent, provided proper training programs and pays fair incentive; this results in effective communication between the employees and management. The company uses advanced technologies in order to manufacture the product and satisfy the needs of the customers. In this way they not only content the customers but the shareholders as they are also benefitted from the sales of the company (Ferdows, Lewis and Machuca, 2004). The cost reduction techniques introduced by the company have enabled it to deliver products to the outlets within 15 days, which is quite a shorter period of time. Internal architecture Three Legged Stool A company cannot employ the external market price for guiding the internal transactions. As a result it has to design administrative devices, as depicts the following: 1) gauging the performance of the company, 2) reward the best performance and 3) partitioning the decision rights. The activities are generally known as organisational architecture; this are performed by the markets and is also performed by the administrative devices inside the company. Applying the internal architecture to Inditex it can be stated that the three activities are well maintained by the company. Firstly, the performance of the company is evaluated with the help of profit and sales revenue. It is observed that the sales and profit of the company has increased over the five years despite of the increasing operating expense due to store opening and renovation purposes. Moreover, in examining the performance of the company, its liquidity is also taken into account. It is observed that Inditex has strong liquidity position as the current assets are higher than the current obligations. Hence, it has the ability to pay off its suppliers and debtors in the long run as it has the right asset base. Secondly, the individual reward system followed by Inditex is quite unique. The employees are given separate incentives for the meeting their targets every quarter. These incentives are for night staffs and also payments are given to the employees, who work over time. These rewards are provided to them in order to motivate and recognize their hard work. Thirdly, the decision making system in Inditex is decentralised. This leads to shorter lead time and more fashionable designs, which are produced by the designers of the company. Interaction between the product and capital market The changes in the product market have direct effect on the capital market. When the sales of a company decrease, the stock market performance also changes to a great extent. The stock prices changes as the revenue and profit of the company increases, the shareholders expect higher returns. In case of Inditex, it is observed that the internal architecture is quite strong to affect the stock price of the company. Hence, it can be stated that as the profit of the company increased over the five years, the share price also increased. This highlights that the shareholders of Inditex has gained confidence over the time because of its performance. Nexus of contract Nexus of contracts indicates the number of contracts that are undertaken by a company with different parties such as directors, stakeholders, employees, suppliers and customers. Inditex uses series of contracts for continuing its business in the long run. Firstly, contracts are made with the suppliers for providing raw materials after a definite period of time. The contracts are renewed after its expiry and the duration depends on the quality of the raw materials that are provided by the suppliers to the company. Financial analysis The financial analysis of the company refers to the interest payout ratio, details of the income statement, balance sheet, cash flow statement and the leasing and off balance sheet records. This indicates how the company has built its financial back up for the past three years. Figure 9: Interest payout ratio (Source: YCharts, 2015) From the above figure it can be stated that the payout ratio of Inditex is observed to have decreased over the years from 2011 to beginning of 2015. The ratio has experienced excessive fluctuations due to the change in economical factors, which affects the share price of the company. Along with that the net income of the company is also an important factor that has the ability to affect the payout ratio. In this case, the net income of Inditex has decreased due to the increase in operating expense of the company. The operating expense has increased as new stores of Zara were established worldwide, which added up to the cost of the company. Hence, according to the P/E ratio of the company, it is not in a strong investment condition. Leasing and Off balance sheet Leasing The commercial premises of the company are leased from the third parties. The leases are named as operating lease, which does not consider the lease terms and the amounts that are paid or kept due to owners for leasing the premises. In this lease there is not particular transfer of the rewards and risks that are inherited to the ownership. The operating lease expenses of the company are detailed below: Figure 10: Operating lease of Inditex (Source: Inditex, 2013) The table indicates that Inditex have to pay a good amount for financing the operating lease. Apart from the operating lease the company has also contracted finance lease particularly for the commercial premises. The leased assets are evaluated in accordance with the plant, equipment and property, which are detailed in the balance sheet of the company. The following table highlights the finance lease of the company. Figure 11: Finance leases (Source: Inditex, 2013a) The table depicts the fact the company has also contracted finance lease, which helps them to continue their business without much problem. Off balance sheet details In case of Inditex, there is no contractual obligation or off balance sheet transactions, which can affect the financial statement to a great extent (Inditex, 2014). ROCE The return on capital employed (ROCE) measure the profitability position of the company along with its efficiency of employing the capital in a proper manner. Higher ROCE is indicative of the fact that the company uses its resources efficiently for generating profit. Figure 12: ROCE of Inditex (Source: Inditex, 2015e) The ROCE of the company has remained stable for the past few years. However, it is seen to decline during 2013 as the operating expense increased to a great extent, which was directly reflected in the ROCE. The operating expense of the company increased as it opened new stores of Zara and also renovated few of the existing one. Competitor analysis LVMH Group is regarded as one of the strongest competitor of Inditex. It aims at serving high quality products to the customers and possess unique portfolio of more than 60 prestigious brands (LVMH, 2015a). It operates in five different sectors such as fashion and leather goods, wines and spirit, watches and jewellery, perfumes and cosmetics and selective retailing (Inditex, 2015b). Figure 13: LVMH Vs Inditex (Source: Bloomberg L.P., 2015a) In the above diagram, the pink line denotes the share price movement of Inditex whereas the blue line indicates the same for LVMH. It can be stated that both the companies have experienced drastic fluctuations during 2014 due to their unstable profit position. Conclusion Inditex has performed well during the phase 2010 to 2013 due to increase in sales revenue and profit. However, with the increase in operating expense of the company during the third quarter has forced the share price to experience a declining trend. The share price movement of Inditex and LVMH has continued to fluctuate during the same period of time; which indicated the fact that economic conditions were not suitable for a stable business. In near future, the company may immense decrease in net profit if it does not check on the operating expenses. Several outlets of Zara are opened in the America, but the customers are not content with the design of clothes as they preferred long outfits rather than short and slim designs. Hence, the sales have declined in the US. In order to cater to the needs of the individual market across the world, the company to perform a thorough research regarding their taste and preference so as to satisfy their needs, this will have direct affect on the product and capital market. Reference List BBC, 2015. Zara-Owner Inditexs Profits Rise By 22%. [online] Available at: < http://www.bbc.com/news/business-21769261 > [Accessed 11 February 2015]. Bloomberg L.P., 2015a. LVMH Moet Hennessy Louis Vuitton SA. [online] Available at: < http://www.bloomberg.com/quote/MC:FP > [Accessed 11 February 2015]. Bloomberg L.P., 2015b. Income Statement [online] Available at: < http://www.bloomberg.com/research/stocks/financials/financials.asp?ticker=ITX:SM > [Accessed 11 February 2015]. Bloomberg L.P., 2015c. Balance Sheet. [online] Available at: < http://www.bloomberg.com/research/stocks/financials/financials.asp?ticker=ITX:SM&dataset=balanceSheet&period=A¤cy=native > [Accessed 11 February 2015]. Bloomberg L.P., 2015d. 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