Zara Case Analysis

How would Zara’s supply chain be considered and rated purely on the basis of theoretical principles? In other words, would it be considered an effective way of managing a supply chain by conventional wisdom? Zara’s supply chain would normally not be considered an effective way of managing a supply chain by conventional wisdom. While they do use a number of popular supply chain practices like outsourcing, global procurement, third-party logistics, just-in-time manufacturing, continuous replenishment, they do many things that goes against conventional wisdom. However, it has been very successful for them.

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They have higher product margins than Gap, H&M and Benetton and have manage to substantially increase their revenues from 2001 to 2002 while the other companies either maintained or decreased their revenues (Exhibit 4). They also have higher market capitalization than both Gap and Benetton, even though those companies have over double the number of stores that Inditex has. Inditex also has a very high return on equity, with an ROE over 20% from 1996 to 2002 (Exhibit 5). If their supply chain was not effective, they would not be as successful as they are.

Conventional wisdom is to outsource anything that is not the company’s core competency. Zara does very little outsourcing, choosing instead to produce more than half of it’s products in-house rather than using individual suppliers. Typically, companies focus on their core competencies and outsource things like manufacturing, transportation and distribution, and financial/human resource/information technology functions to third-party logistics (3PL) and fourth-party logistics (4PL) providers. Zara outsources very little, choosing to keep many of these functions in-house.

One of the biggest problems of any supply chain is minimizing the “bull-whip” effect. This is when information about the customer’s actual demand is distorted and amplified as we move up through the supply chain. Zara is able to use their point of sale terminals and information to transmit the customer’s actual demand right to their manufacturing facilities. Communication is essential in all supply chains.

One of the supply chain manager’s tasks is managing people and getting everyone to communicate. They also have consolidation in distribution. They only use two major distribution centers (DCs) located in Spain to replenish their stores throughout the world. They have several small local DCs in Latin America, but those are still replenished from the two Spanish DCs. Their supply chain needs to be as simple as possible, since complexity in the supply chain increases lead times and is open to more disruptions and problems. To this end, Zara uses a direct supply chain, without 3PLs or 4PLs, and keeps everything in-house, which results in very short lead times. Communication and simplicity help reduce the effects of the bull-whip effect.

With globalization, this practice of having only a few DCs, as well as factories that are located far away from their markets goes against the modern theories of supply chain management. Theoretically, they should source the goods from other companies, based on the location of those companies and on the total cost of goods from those companies, rather than producing the goods themselves. They should also use 3PLs to coordinate the logistics of distribution chain. However, if Zara were to do this, they would lose their flexibility and increase lead times, which goes against their business strategy.

A major theoretical focus of supply chain management is the size and frequency of the order, shipment and payment flows (demand, supply, and cash). Most companies in the fashion industry use economies-of-scale which favour larger, infrequent orders and shipments. The other approach, which Zara uses, is minimizing inventory costs which favour smaller quantities and more frequent shipments.

Zara uses vertical integration in their organization. This consists of activities that are upstream (towards suppliers) and downstream (towards the customers) in the supply chain. This vertically integrated system encompasses design, just-in-time manufacturing, marketing and sales. Theoretically, this is a more risky and most companies have moved away from vertical integration but for Zara, this is the key to their success. In the fashion industry, most of the costs are in the downstream supply chain, due to demand uncertainty, as well as inventory and distribution costs. Zara is able to minimize these costs since they react to customer demand rather than forecasting what they think demand will be. They also have minimal inventory at any point in the supply chain, and are able to minimize distribution costs through their logistics.

As for the upstream costs, raw materials accounts for the bulk of the costs. Labour can be a large component of the costs, which is why companies are typically sourcing production to low-cost countries; they use the “China price” strategy where they find the lowest cost producer. Sourcing the labour and production to low-wage countries reduces the costs for the company, but increases lead times.

The long lead times mean that companies have to do long range forecasting and planning and cannot react quickly to changes in the market. Zara has been able to reduce the lead times down to under a month to design, produce and ship a new product by buying large quantities of raw materials (fabric) and keeping the labour in-house (for the most part). They still source the sewing of the garments to lower-cost facilities, so they are able to reduce costs while still keeping the lead times fairly short. The upstream and down stream logistics contributes to the value chain of the entire system; all activities add to the value of the output of the firm.

The expansion of the company and opening new stores can place stress on the supply chain. Inditex opened on average one store per day across the world and Zara accounts for approximately 34% of the stores (531 out of 1,558 stores are Zara). Of the 531 stores, 419 of them (79%) are located in Europe, with 200 of them being in Spain. For most companies, expanding at this rate would almost cripple the supply chain as changes in the supply chain are slower than opening a new store. Since the majority of the stores are located in Europe and are close to the two DCs in Spain, Zara is able to open new stores without disrupting the supply chain.

Zara does not need to use inventory management practices such as vendor managed inventory, since they produce the majority of the stock in their stores. They are able to manufacture and sell the clothes without requiring vendors to monitor the stock and replenish the shelves. Zara operates using both a push and a pull strategy. Certain products are pushed through the supply chain to the stores to determine the demand for those products. The commercials determine what products they want to test at the retail locations and ship those out to the stores. The majority of the products are pulled through the system based on actual customer demand. The POS information is used to determine what products the stores will carry.

Overall, many of the elements of Zara’s supply chain go against conventional wisdom. If a new company were to present a business plan with this type of supply chain that goes against most of the theoretical principles of supply chain management, most experts would probably predict that their company would fail. However, Zara’s supply chain is very strong and gives them a competitive advantage in their industry.