From: McKelvey, Michelle

Sent: Sun 3/6/2011 7:32 PM

To: Amancio Ortega
Subject: Zara 2011 Deliverable Report

Mr. Ortega,
It was a pleasure meeting you in the elevator last Tuesday. I would like to follow up on our conversation
regarding the state of Inditex. As I mentioned to you in our previous discussion, I have been extensively analyzed the
status of your company, its products, and its main competitors for the past few years. Before moving forward, I must
congratulate Zara¶s vast expansion and growth throughout the past few years. The company has remained focused on its
core fashion philosophy: that creativity and quality design, coupled with a rapid response to market demands will yield
profitable results. Nevertheless, the subsequent question regarding this expansion remains:

‘ èow will Zara sustain financial growth and solidify a strong market position in 2002?

Currently, Zara appears to have an agenda for ensuring successful expansion. èowever, after a deeper analysis, four
pivotal strategic issues have been identified which could either stifle company growth, or propel Zara to successful
expansion. These strategic issues include:

‘ European market expansion

‘ Inventory management
‘ Future growth opportunities

In order to mitigate these matters, I suggest the following:

‘ Focus on UK, Switzerland, Portugal, and Austria markets

‘ Restructure Inventory Management Strategy
‘ Expand to the United States market

While Zara¶s inventory levels have quickly flourished, the company¶s sales growth rate has suffered. These
strategic issues will provide a strategic solution for Zara to sustain the increased inventory levels, sustain sales growth and
uphold the company¶s value proposition of offering new, moderately prices faster than other retailers. Within the past
years, Zara has experienced significant revenue growth, increased profit margins, and elevated inventory levels. èowever,
with the increasing pressures of competitors (The Gap, èennes and Mauritz, Benetton, and specialty retailers), the global
apparel market is becoming bloodier and bloodier. In efforts to ensure Zara¶s competitive within the market, these
recommendations have been extrapolated from an extensive company analysis, and implementation suggestions have been
outlined in detail within the report. I believe these suggestions are pivotal for Zara to ensure sustainable growth and
establish itself as a market leader in the global apparel market.

Sincerely,

Michelle McKelvey
Gertz Consulting
mmckelvey1@babson.edu
571.294.8827

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The first topic addressed is the company¶s expansion into international markets. It is essential for Zara to leverage their
current assets in four primary countries: the United Kingdom, Switzerland, Portugal and Austria. These four areas have
been selected for their greatest opportunity for growth within their respective markets (please refer to Exhibit 5). These
markets demonstrate the most potential for Zara to increase their total sales and provide a strong platform for future
expansion.
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According to an industry report by Grant Thorton LLP, ³retailers with a strongly defined base, a
trusted brand name, and an effective multi-channel distribution operation have a very strong chance of succeeding in the
United Kingdom retail industry.´1 Currently, the total apparel market has a value of ten billion dollars and is expected to
grow to nineteen billion by 2006.2 This market also has the second highest GNP compared to other countries. In addition,
the United Kingdom has the second largest population which displays an attractive, large customer base and a strong force
for revenue generation. Moreover, the country has the lowest number of retail outlets and has the second highest amount
of total sales per outlet. Overall, these figures demonstrate a relatively unsaturated market and strong consumer
purchasing power.

Similarly to the United Kingdom, Switzerland houses a stable economy with a per capita GDP of 20%
higher than fellow western European economies3. In addition, the country has the third highest total sales per person and a
low number of sales generated from specialty retailers. Through this, it can be speculated that this market has a strong
consumer purchasing power and a growing demand for large retailers. Zara strongly values efficient distribution and short
lead times, which is synonymous with Switzerland¶s short geographical distance to Spain causing it to be advantageous
for Zara to penetrate this market.

 Although the United Kingdom and Switzerland have proved to be stable economies, Portugal is a prime area for
current growth. Since 1985, the country¶s GDP has rose from 51% to 78% in 20014. Moreover, Inditex currently owns
562 retail outlets in Portugal, 38 of which are Zara stores. The strong parent brand presence provides an excellent
foundation for Zara to enter the market. Furthermore, specialist retail stores occupy a meager percentage of the apparel
market. Portugal¶s retail market has low barriers to entry and shows a possible demand for the entry of a larger retailer.
They are located very close to Zara¶s headquarters, which will ensure shorter lead times. Through the culmination of these
factors, it can be determined that Portugal is a country destined for growth, of which Zara must capitalize upon it.
Finally, Zara should increase their retail presence in to Austria. Zara currently operates a mere three stores in this
region, while Austria has the lowest number of apparel outlets, coupled with the highest total sales per outlet and the
second highest total sales per person. These statistics display strong consumer purchasing power, low barriers to entry,
and a relatively unsaturated retail market. Penetrating this market would provide a viable opportunity for Zara to position
themselves as a premium retailer in a strong economic environment.




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With regards to immediate expansion, Zara should forego activity within the Asian retail market. While the allure of
low high production margins may be tempting (please refer to Exhibit 4), this market is laced with fierce competition and
extremely high barriers to entry. These factors would squeeze the seemingly high profit margins, which would hinder
Zara¶s ability to compete on price with established retailers. In addition, this would require an immense amount of
resources and human capital, which could have been allocated towards a more attractive market. In terms of production,
Zara¶s factories offer more flexibility and control than outsourcing production to Asia (regardless of lower costs).
Through leveraging Zara¶s brand in these four European markets, a foundation will be formed causing Zara¶s penetration
within Asian markets to be more advantageous to the company.
I firmly advise you, Mr. Ortega to halt further expansion in Spain¶s retail market. Zara has already established a
significant brand presence in Spain through opening over 166 retail stores over the past two years, which accounts for
29.95% of Zara¶s total retail store growth. Moreover, as demonstrated in Exhibit 5, Spain has very low total sales per
person ratio, very low total sales per outlet ratio, and a very low GNP per capita. Zara should focus on strengthening their
brand in other economies and acquiring a new consumer base. Overall, this is not an attractive market in which to
continue efforts.
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In order to benefit most from the target areas listed above, Zara must place increased efforts towards its Inventory
Management Strategy. In order to increase the efficiency of inventory management, Zara must formulate more accurate
forecasting models and develop a more efficient distribution system in order to efficiently manage their inventories. This
will aid in maintaining the collection of 85% of their full ticket price and high margins. èowever, gross margins are
meaningless if inventory is not sold. As stated by Jose Maria Castellano, ³This business is all about reducing response
time. In fashion, stock is like food. It goes bad quick.´
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 After a thorough analysis of Zara¶s financial statements (please refer to Exhibit 1 and Exhibit 2), it is clear
that Zara¶s cash conversion cycle has increased by an alarming 90% from 1999-2001. èowever, as we peel away the
layers of this figure, the root of the problem is the drastic 9% increase in Days Sales of Inventory. This suggests that as
Zara expands globally, management is having difficulty predicting and allocating inventory levels and amounts in new
markets. On a local level, store managers cannot see the consolidated demand of nearby retailers, and therefore,
cohesiveness between nearby Zara outlets is inexistent. The fact that these store managers do not communicate inventory
levels, and other relevant information, inadvertently causes a disconnect within forecasting. Moreover, precise forecasting
is essential for Zara to sustain the 14.32% increase in their inventory levels. To mitigate this problem, Zara should invest
capital and time into extensively researching local market trends and increase inventory visibility between nearby
retailers. These improvements will allow Zara and local management to increase the accuracy of inventory forecasts
thereby decreasing days sales of inventory, and inventory turnover -ultimately yielding a stronger sales growth rate. 


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Although accurate forecasting is essential to Zara¶s business model, Zara must
also refine their information technology infrastructure to sustain their inventory growth. The new team members would
focus on developing, testing, and implementing a new operating system. Zara currently utilizes a hybrid model of human
intelligence and IT which drive information flow from local stores to corporate headquarters. If they implement a new
operating system, this would enable the installation of modern software applications and would increase Zara¶s business

  
capabilities and increase efficiency. This new system would encompass the old benefits of Zara¶s current information
system, but also harness communication between local stores. For example, a new software could be used to automatically
update the POS terminals after every sale, which would increase access to ³real time´ information and allow the design
team to react faster to forthcoming trends and store inventory levels on both local and national levels. As we noted above,
Zara has encompassed several deficiencies regarding instilling communication between its various levels of retail outlets.
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In addition to their twenty company owned factories, Zara should purchase the 450 workshops in
Galicia to fully vertically integrate their supply chain. Currently, Zara owns the cutting, processing, and dying processes
of their supply chain. Conversely, they outsource the stitching process to 450 workshops in Galacia. Although this process
is labor intensive, if they buy the workshops, Zara would not have to ship out products, wait for them, then redistribute
them to stores. This would streamline the supply chain, which would decrease lead times and increase production control.
Zara should formalize contracts with their suppliers in efforts to decrease lead time. They should not increase their
capacity of their current CDS. As capacity utilization begins to increase, waiting times increase gradually. As demand
becomes more variable, the acceleration starts at lower levels of capacity utilization. Thus, a higher the capacity, yields a
capacity utilization which remains low and thus, the waiting time does not increase (please refer to Exhibit 6). Overall,
this would increase their in house production capabilities to from 40% to approximately 50% and streamline their supply
chain. Moreover, they should look towards expanding in the United States market through expanding their satellite
distribution center in Mexico.
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In addition to increased growth in European markets, Zara should also consider expansion in the United States retail
market, which currently holds 29% of the total global apparel market5. èowever, Zara¶s vertically integrated supply chain
has hindered the company¶s ability to grow and has caused dis-economies of scale. In order to combat this problem, Zara
should make their current distribution center in Mexico a hub for North and South American production and inventory
management. This will aid Zara in achieving economies of scale because it will be much easier to understand their
consumer, forecast product demand, and ultimately acquire significant cost advantages. In order for this expansion to be
successful, the company must solidify a strong brand position, strategically segment their product lines, and establish an
efficient inventory management strategy.
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Thus far, Zara has done an excellent job of thinking global, but have failed to act local. Zara has defined
their broad consumer base as fashion conscious city dwellers with middle to middle-high income and is positioned as a
trendy, moderately priced retailer. èowever, upon initial entry into the United States market, Zara¶s brand equity must be
built around their core customer. Through an extensive consumer analysis, we believe Zara should initially target females,
ages 18-22. Once brand loyalty is established, the company can then extend their target market to 18-34 females.
Although this will increase advertising and research costs, Zara currently spends approximately 92.5% less than their
competitors on marketing efforts. The company should increase advertising costs from 0.3% to 1.2%, which will enable
Zara to focus on specific geographic segments (New York vs. Miami) and age segments (18-24 aged females vs. 25-32
aged females). This market research, segmentation, and trend analysis will be more efficient and easier because of

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Mexico¶s close proximity to the United States. Inditex already has 184 stores, coupled with seven Zara stores. The
company can use their parent brand presence and resources to help build their brand reputation.
In terms of determining the locations of these new stores, we recommend Zara sign a ten year lease for these company
owned and joint venture stores in large cities (in order to maintain tight control of their brand), and franchise stores enter
into a five year lease in lower traffic areas. Zara should enter into a longer lease in larger cities with higher purchasing
power, because we believe Zara will be more successful in those markets. In addition, the fashion forward product lines
should be concentrated in cosmopolitan cities because they are located near major airports and are typically home to
fashion forward, trend conscious consumers with a greater purchasing power. Moreover, we have identified three key
components (social media, e-commerce site, and competitor history) that will drive brand equity in the United States
market: Firstly, Zara should heavily utilize social media when expanding to the United States market. Social media
provides customers with fast information, which aligns with the company¶s value proposition of fast fashion. Social media
can generate powerful viral marketing buzz at a low cost. Secondly, Zara should strengthen their e-commerce site.
Although not every product will be sold on their site, Zara can initially sell their basic clothing lines then expand to
offering more fashion forward lines. Thirdly, it is essential that Zara analyze the failures of their competitors. GAP failed
because it did not reposition itself as a fashion forward company. GAP had a very high COGS (70% COGS vs. Inditex¶s
48%) and high operating expenses (92% of their gross margin vs. Inditex¶s 58%). Zara must ensure to keep their costs low
and operating costs low through accurately forecasting demand and understanding the American consumer.




Zara¶s production chain is heavily design driven, market price driven, and focused on lean
production. Currently, Zara develops 10-15% of the products that vary each season (fashion items) with little regard to
each countries market trends. Even with the increase in globalization, tastes still vary widely between countries. The
consumers pull, not the designers push drives the retail demand curve. Nevertheless, as mentioned above, we believe Zara
should segment their broad target market and offer product lines tailored to different market segments. Because this
distribution center is close to the United States, the product management team can increase the accuracy of forecasting the
trends for the next season. In addition, Zara has a design team of 200 employees which produce 12,000 designs per year.
We propose an addition of five designers to the design team, which will specifically focus on creating designs and
analyzing trends for the United States market. This would expedite the product development process and lead to shorter
throughput times in the Mexico distribution center.


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With this expansion into the United States market, Zara should expand the capabilities of
their smaller just in time distribution center in Mexico. Products can still be purchased centrally, and directly shipped
from Comidtel to Mexico for manufacturing and distribution instead of shipping through Spain, which would decrease
lead times and lower shipping costs. The new distribution center can then quickly ship fashion forward items to
cosmopolitan cities (New York City, Los Angeles and Miami) within 24 hours, instead of shipping from Spain which
takes 24-48 hours. They can also maintain tight control of production, United States market trends, sales and product
information, directly control capacities, production scheduling, and manage distribution. This will yield more accurate
data collection, higher quick response, and a higher product turnover per store. Although this might result in an increase in
manufacturing costs (increased labor and facilities costs in Mexico), this cost will be offset by reduced shipping, tariff
costs, and increased ability to forecast inventory levels as well as market trends.
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Net Profit Margin 10.06% 9.91% 10.47%
EBIT 410.5 521.5 704.4
EBIT Growth Rate 26.07% 27.04% 35.07%
Asset Turnover 1.15 1.24 1.25
ROA 11.54% 12.30% 13.07%
ROE 22.90% 22.10% 22.90%
Sales Growth Rate 26.04% 28.48% 24.29%
Inventory 188.5 245.1 353.8
Inventory Growth Rate 19.53% 30.03% 44.35%
Inventory Turnover 5.71 5.89 5.22
Accounts Receivables 121.60 145.20 184.20
Receivable Turnover 20.70 19.60 19.73
Accounts Payable 276.10 323.00 426.30
Accounts Payable
4.02 4.26 4.17
Turnover
Days Sales Outstanding 17.63 18.62 18.50
Days Sales of Inventory 63.92 61.97 69.92
Days Payable
90.79 85.62 87.48
Outstanding
Cash Conversion Cycle -9.24 -5.03 0.94




  
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Operating Cost / Total
30.22% 27.48% 37.83% 29.74%
Sales
Net-Income per employee 12,722.65 (54.22) 17,869.60 22,182.25
ROE (net income / equity) 22.88% -0.27% 24.85% 11.93%
Asset Turnover 1.25 1.82 1.96 0.74
Financial Leverage 1.75 2.52 1.32 2.27
Current Ratio 1.02 1.48 3.40 1.63
Gross Profit Margin 51.91% 29.92% 51.63% 43.33%
Net profit Margin 10.46% -0.06% 9.60% 7.05%




  
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Germany 18 23 0.78
Spain 7 11 0.64
Italy 14 20 0.70
Portugal 4 6 0.67
UK 11 13 0.85
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Turkey 2 12 0.17
China 0.4 n/a
India 0.4 2 0.20
Egypt 0.7 2 0.35


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US 10 20 0.50
Japan 14 n/a




  
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 #
$
%X
Japan 231%
USA 209%
Canada 178%
Kuwait 171%
Saudi Arabia 170%
Bahrain 170%
Mexico 164%
Qatar 160%
Poland 158%
Denmark 153%
Lebanon 152%
UK 151%
Venezuela 147%
Cyprus 136%
Spain 100%


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Lowest Distance from Spain Portugal France Switzerland
èighest Distance from Spain Finland Sweden Greece

èighest GNP per Capita Switzerland Denmark Sweden

Lowest GNP per Capita Poland Greece Spain

èighest Population Germany UK France

Lowest Population Ireland Finland Denmark

èighest Total GNP Germany UK France

Lowest Total GNP Ireland Portugal Finland

èighest # Total Outlets Italy Greece Netherlands

Lowest # Total Outlets Austria Finland UK

èighest Total Sales / Person Italy Austria Switzerland

Lowest Total Sales / Person Portugal Finland Spain

èighest Total Sales / Outlet Austria UK Finland

Lowest Total Sales / Outlet Spain Greece Italy

Lowest Specialist Sales (Euros/sq. meter) Switzerland Greece Portugal

èighest Specialist Sales (Euros/sq. meter) Italy UK Germany

èighest Specialist Sales of Apparel Sales (%) Sweden Italy Germany

Lowest Specialist Sales of Apparel Sales (%) Denmark Portugal Ireland


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