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STRATEGIC MANAGEMENT

Key Sources of ZARA's Competitive Advantage

Assignment 2
MEMORANDUM

TO:
FROM:
DATE: 13 July 2017
SUBJECT: Sources of ZARA's Competitive Advantage from a quantitative perspective

Detailed Analysis of Zara's Competitive Advantage


The following financial ratios have been extracted from the financial details published by Inditex
and its rivals annual reports of 2001.
As Zara accounts for the majority of Inditex's operations, an analysis of Inditex financial data can
be considered as a true reflection of Zara's financial performance.
Financial Ratios The GAP H&M Benetton Inditex
Return on Sales 2% 14% 14% 22%
Working Capital / Sales 7% 24% 29% 1%
PPE/Sales 30% 15% 34% 38%
Asset Turnover (sales/assets) 1.82 1.96 0.74 1.25
Return on Assets 0% 19% 5% 13%
Debt/Equity (Ratio) 1.52 0.32 1.27 0.75
Return on Equity 0% 25% 12% 23%

Return on Sales (ROS)


Return on sales demonstrates the proportion of operating profits in relation to net sales.
Inditex demonstrates a competitive advantage over its rivals in this respect due to:
 The short design and production lead times, it can take advantage of fashion trends
(including ability to make any necessary adjustments mid-season) to ensure that items
that are selling well are available for sale quickly.
 Slow selling items are identified and quickly phased out. Due to low volume batch
production, Zara would not have significant overstocks at the end of the season that
would need to be marked down for such items (15% vs industry average of 30%).
Additional product at full price translates to better returns.
Working Capital to Sales Ratio
This indicates the amount of Zara's money that is utilised or tied up in its operations to
generate sales. Zara enjoys the lowest working capital to sales ratio among its rivals, which
is another competitive advantage. This is achieved by:
 Procurement of materials done in small batches and done on a "just in Time" basis, to
ensure that there are no excess stocks of materials.
MEMORANDUM

PPE to Sales Ratio


PPE ( Property, Plant and Equipment) to Sales ratio indicates the value proportion of PPE in
relation to net sales. Zara's PPE/Sales ratio will be high as it carries out its own
manufacturing of items when needed and also the fact that the majority of its stores are
company owned.
 The competitive advantage of Zara is evident in the fact that its PPE/Sales ratio is only
slightly higher than GAP and Benetton. GAP outsources all is manufacturing and therefore
should in theory have a low PPE/Sales ratio.
Return on Assets (ROA)
ROA is the measure of net income as a proportion of total assets. Its a measure which can
be best described as how hard the assets are working to generate income.
Zara's manages to generate a ROA return closer to H&M, which outsources all its
manufacturing (and therefore is considered as asset light). This demonstrates the value
addition/generation directly attributable to its manufacturing plants

Debt to Equity Ratio


Debt to Equity ratio demonstrates the financial stability of an Entity, with lower ratio's
being considered as being more stable as it would indicate that the amount of debt (and
hence interest payments) would not create a significant financial drag to the organisation.
Additionally

Comparison of Zara's Operating Margin to an average retailer


A comparison of Zara's advertising adjusted margin against an average retailer confirms that it has
a comparative advantage of approximately 5% (of sales). This demonstrates that by vertical
integration it has been able to create extra value/extract additional margin.
Avg Retailer -
Avg Retailer - Imports from
Mfg In Spain Asia Inditex/Zara*
Selling price (€) 84.5 40.2 3250.0
Cost (€) 42.2 20.1 1563.0
Gross Margin (€) 42.2 20.1 1687.0
less Advertising costs (€)** 2.5 1.2 9.8
Advertising adjusted margin (€) 39.7 18.9 1677.3

Advertising Adjusted Margin % (of


sales) 47% 47% 52%
* Intidex financials from 2001 annual report used for comparison purposes
MEMORANDUM

** Assumption that average retailers spend 3% of revenue on advertising, inline with industry
average vs 0.3% by Zara

Summary
Zara's is able to analyse trends in retail and use them to rapidly influence design, production and
distribution changes as needed. Zara's competitive advantage/edge over its rivals, is the flexibility
it demonstrates in achieving this quickly and with minimum penalties or disruption to its supply
chain.
To achieve this, it has created an end to end supply chain that uses sales/retail feedback to a great
extent to influence subsequent design, sourcing/production, distribution and retailing activities.
All support functions are centralised, organised and integrated to support this approach and
provide the necessary flexibility.
A comparison of the financial data of Inditex (Zara's parent company) provides the evidence of this
competitive advantage to a significant degree.