Inditex Dazzles its Competitors Again

The European fashion industry is not enjoying the best of times. The apparel market registered sales of €224 billion last year, according to Datamonitor, the consultancy. That means it has barely grown since 1999. Experts disagree about the key reason for this recession. They point to several different causes, including declining consumer spending, high competition in the sector, and production from Asian countries. Companies such as Benetton have warned that weak consumer spending will have an impact on its earnings.

  

Isabel Díez Vial, professor of strategic management at the Complutense University of Madrid, says that “in 1999, the average spending on clothing represented 5.5% of total consumption in Spain. Nowadays, it represents 5.4%. Nevertheless, the trend in Europe anticipates a growing decline. For example, in Italy, France and Germany, there has been a 10% reduction during the same period.”

 

These days, consumers apparently prefer to do their shopping in major clothing chains, not shops that sell several brands at once. “The growing concentration in major retailers is not a favorable trend for the sector. Consumers are no longer shopping as much in the multi-brand shops,” says Díez. Independent shops have lost 10% of the market, and their market share has dropped from 36% in 1999 to 32% in 2005. Meanwhile, the big chains grew by 21% over the same period, according to the consultants at Euromonitor.

 

Asian Competition

 

Another factor is growing competition from countries that have low wage rates. The greatest threat comes from Asia. “These countries offer cheap labor, and have a great ability to copy any product,” says Díez. “That forces companies in the rest of the world to change the way they behave.” Spain’s textile and apparel industry is expected to lose between 15,000 and 20,000 employees this year. In addition, some 400 companies in the sector are expected to disappear. That’s the highest number in recent years. Those companies are largely in the center and south of Spain, and they can no longer compete against low prices from companies in Morocco, Tunisia, and Asia.

 

Who is responsible for the crisis? Pedro Nueno, professor at the IESE and founder of the China Europe International Business School, told Expansión, the Spanish business daily that “Europe has spent all these years with a tranquil sense that their competitors were never going to arrive. This shows the total failure of industry to look ahead because business leaders are the first people who are responsible. Business organizations are second, and the third group is the government. At least one of the three groups should have seen clearly that there was no future in pursuing certain kinds of activities. It is not right to tell us now that the Chinese are the bad guys [who are responsible].”

 

Díez says that companies cannot afford to stand on the sidelines simply watching the Asian competition. They have to react. One way to deal with competition is to lower your prices, “which implies relocating production in order to reduce production costs so you can lower prices,” notes Díez. She believes that the strategy that has the greatest potential to help [apparel and] textile companies break free of Asian competition is to “try to offer something different in order to establish brand reputation.” This seems to have been the maxim of the Inditex group. Its Zara brand has become one of the world’s leading brands, ranking with Coca Cola, Microsoft and Disney, and above such brands as Levi’s and Armani. Zara ranked 77th in the rankings created by Interbrand, the brand consultant, as published in BusinessWeek. According to Interbrand, the Zara brand is worth $3.076 billion. This is the first time that a Spanish company has made this international listing.

 

The Customer Rules

 

Díez is certain that the apparel and textile sector “needs a major restructuring so that it can define a clear competitive advantage and focus on quality.”

 

When it comes to that approach, Inditex is once again Europe’s shining star. The company’s net profits reached €246.2 billion during the first half of this fiscal year, which runs from February through July. That was a 29% increase over the previous year, and the company’s best results since it went public in 2001. Revenues reached €2.819 billion, up 19.87% from last year.

 

A key reason for the growth was that the company opened 160 new stores. Another factor was the positive reception to its winter collection. It is important to recognize winter clothing yields the highest profit margins of any season. Fashion chains’ earnings depend on how well consumers accept new collections and how well companies react to the changing taste of their customers. “The fashion industry always faces the risk of how well the public accepts its collections,” José María Castellano, Inditex’s former vice-president, used to say.

 

Inditex has learned how to adapt itself to changing times. Currently the third-largest company in the fashion sector after only H&M and Gap, Inditex knows how to react to consumer tastes. Inditex has changed the very nature of competition in the process of achieving that goal. “Inditex has turned the dynamics of the sector upside down,” notes Díez. “It has done away with the summer and winter seasons and their corresponding periods of discounted ‘sales’. This change, which might look ridiculous, has transformed competition within the industry.”

 

The business model for Zara is based on offering the latest style in a high quality product at a good price. In Zara shops, there are two new collections every week, and the company manages to design, produce, distribute and sell each of its collections in just four weeks. In contrast, its competitors take several months. In addition, the group does not spend even one euro on advertising.

 

“The customer doesn’t go to the store at the beginning of summer or winter, and see what they want, and think about it and decide later what to buy,” says Díez. “Instead, the customer has to go to the shop every 15 days because the collection is refreshed so frequently. This approach, known as the ‘Inditex revolution,’ can be clearly seen in Zara Home, the division that focuses on the home. Who would have thought that people would buy and replace sheets, glassware and dishes according to the latest changes in style? This approach leads to a complete change in the production process. Instead of offering products that take a year to plan and sell, you now have a product that the customer demands. This change is about moving away from the usual focus on production, and towards a focus on the customer.”

 

This ability to understand the world of fashion and the taste of consumers is “Inditex’s big competitive advantage,” says Díez. “Nevertheless, even an ingenious idea won’t be a success if your planning process isn’t first-rate.” 

 

Stronger Than its Competitors

 

Along the same lines, Díez adds, “Although Inditex’s main rivals — GAP, H&M and Benetton — do not manufacture their collections, the Spanish company [Inditex] is vertically integrated. That gives Inditex greater responsiveness and flexibility.” Inditex was established by multimillionaire Amancio Ortega, who was rated the 18th richest man in the world on the Forbes magazine ‘rich list.’ Inditex surrounds itself with a network of small manufacturing companies that feed it and provide flexibility.

 

Inditex also owns its own shops. Like Inditex, Benetton manufactures its products in small factories, but Benetton operates retail franchises that are owned by third parties. “This control over the point of sale enables Inditex to be in direct contact with the customer,” says Díez. “Consider this detail: The sales clerks in Zara are obliged to communicate the requests of their customers [to management], including even the suggestions that customers make in fitting rooms,” she adds.

 

Following up on its good results in the first half of this year, Inditex has been focusing on the second half, when the company usually generates 70% of its annual profits. Inditex expects to open between 400 and 450 new establishments by the end of this fiscal year after opening 322 shops last year. The company’s strategic plan for the next five years projects a doubling of its size. By 2009, it wants to have 3,800 shops around the world (it now has 2,453) and sales of €10 billion.

 

Like Inditex, apparel retailer H&M has not seen its sales decline despite the overall weakness in European consumer spending. The Swedish manufacturer improved its net profits by 33% over the first nine months of the fiscal year, reaching €640.5 million. Its revenues during that period rose 14% to €5.407 billion.

 

H&M is Inditex’s largest competitor, and it attributes its results to better control of its margins and to the opening of 76 new shops. H&M now has 1,134 shops around the world. During the second half of this year, H&M is planning to open 70 new outlets, mainly in the United States and Canada, while closing 10 of its other shops. The chain is also studying the possibility of selling products by mail and through the Internet in Holland.

 

Although its revenues lag behind those of H&M, Inditex has a competitive edge. The Swedish chain’s business model focuses on designing and selling but H&M outsources its production [to contract manufacturers], and that limits its speed to market. H&M has warned that the re-imposition of quotas on [textile and apparel] imports from China will make it harder to buy clothing in that country. That could have a negative influence on H&M’s operating profits. Some 30% of the chain’s clothing is purchased from China.

 

U.S.-based Gap Inc. is another direct rival of Inditex. Gap earned a profit of $1.150 billion during fiscal 2005, which ended in January, up 11.7% from the previous year. Its sales rose 2.6% to $16.267 billion.

 

According to a report by BBVA, the Spanish bank, Gap is a multi-platform brand based on a single image. Its business model is similar to that of H&M, focusing on its own design and sales but outsourcing its production to others. The company has enjoyed strong growth in the United States but it has only a minor share of the market in Europe. Its positioning is less tied to style than that of Inditex, and its pricing is less aggressive. Some years ago, the chain indiscriminately opened shops in several European countries. It was forced to close some, including several in Spain.

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