The Fast-Fashion Business Model: O D H C An Overview Based On The Zara Case

The Fast-Fashion Business Model: An O Overview Based on the Zara Case d h C
Felipe Caro
UCLA Anderson School of Management & Depto. Depto de Ingeniera Industrial, U. de Chile Industrial U fcaro@anderson.ucla.edu
Taller "Rocket Science" en Retail 2008, Santiago, 19 de Junio g ,

The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 Felipe Caro
Presentation Outline
Motivation
Recent brand value data How fast is Fast Fashion?
What is Fast Fashion?

Business strategy/Operations strategy Two F t Fashion examples T Fast F hi l Fast Fashion open questions
Research Collaboration with Zara

Inventory allocation model Clearance pricing optimization
Conclusions
Motivation: Recent Brand Value Data
Source: BusinessWeek / Interbrand (2007)
The Fast-Fashion Business Model: An Overview Based on the Zara Case
2008 Felipe Caro
Zara and the Fast-Fashion Strategy
Top Global Brands 2007 p 2
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2008 Felipe Caro
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T Top Europ pean Retail Brand 2008 ds
Source: Interbrand (2008)
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Motivation: Fast-Fashion Assortment Rotation

Trad dition nal Reta ailer
selling season assortment t
time
Fast-Fashi ion Retai iler
Vs s.
assortment
2008 Felipe Caro
Motivation


Conclusions
What is Fast-Fashion?
Business Strategy: gy Cutting-edge fashion at affordable prices Operations Strategy: builds on Quick Response
Quick Response: similar to what just-in-time manufacturing has meant to the auto a u actu g as ea t t e industry (Hammond and Kelly 1990)
2008 Felipe Caro
Fast Fashion Operations Strategy

Structural choices (tangible, hardware)
High level o vertical integration (includes store ownership) g of a g a o ( ud o o p) Tight control of production (either through ownership or permanent monitoring) pp y ( ) Dual supply chain (SC): Basic items: efficient SC (minimize cost) Fashion items: responsive SC (minimize lead time) p y Simple but effective IT systems Modern distribution centers
Infrastructural choices (intangible software) (intangible, software )

Cross-functional decision making highly centralized Fashion items produced in small batches Frequent assortment changes trying to follow fashion trends Daily information exchange with store mangers Strong operations-driven organizational culture
2008 Felipe Caro
Two Examples of Fast-Fashion

Zara (Spain) Vertical Integration (2007) No. of stores worldwide (2007) No. of Countries (2007) Distribution of Stores - Main Locations (2007) Fully integrated. Subcontracts cutting, sewing, and shipping 1,361 68 13% North Europe 60% South Europe 7% East Europe 8% Latin America 5% Asia Pacific 34% Asia 50% Spain & Prox. 14% Rest of Europe 40% Basic 60% Fashion Efficient SC: 6 Months Responsive SC: 2-5 Weeks Twice a week Overall, higher than H&M (especially out of Spain) 0.3% of Revenues H&M (Sweden) Controls of every link in the chain but does not own factories 1,522 28 63.5% North Europe 19% South Europe 5% East Europe 12% North America >60% Asia <40% Europe >70% Basic <30% Fashion Efficient SC: 6 Months Responsive SC: 3-6 Weeks Daily y Lowest among Fast Fashion 3-4% of Revenues The Gap (U.S.A.) From design to store but outsources production >1,572 21 9% United Kingdom 79% North America 7% Japan
Sourcing - Main Suppliers (2006) Assortment Composition p (2006) Lead Times - Dual SC (2006) Refresh Fashion Items (2006) Pricing (2002) Marketing Expenditure g p (2002)
97% outside U.S.A.
99% Basic Efficient SC: 9 Months Occasionally y Comparable to Zara, if not higher Comparable to H&M p
Source: Annual Reports and Public Press
2008 Felipe Caro
Two Examples of Fast-Fashion

Inditex (Euro) Revenue (Net Sales) Gross Margin Operating (EBIT) Margin Net Margin (ROS) Working Capital /Sales Inventory Turns Asset Turnover ROA Leverage ROE 9,435 9 435 8,196 56.7% 56.2% 17.5% 16.6% 13.3% 12.3% -6.1% 6.1% -6.1% 4.06 4.36 1.33 1.43 17.7% 17.6% 1.69 1.67 30.0% 29.3% H&M (SEK) 78,346 78 346 68,400 61.1% 59.5% 23.5% 22.4% 17.3% 15.8% 9.7% 10.2% 3.83 3.84 1.88 1.92 32.6% 30.4% 1.30 1.28 42.3% 38.9% Gap Inc. (US$) 15,763 15 763 15,923 36.1% 35.5% 8.3% 7.7% 5.3% 4.9% 10.5% 17.3% 6.39 5.72 2.01 1.86 10.6% 9.1% 1.83 1.65 19.5% 15.0%
Source: Annual Reports p
2007 00 2006
1 SEK = 0.107 1 US$ = 0.65
2008 Felipe Caro
Vertical Integration
Manufacturing Zara World Co. Design Distribution Retailing
H&M The Gap
Benetton Mango
H&M does not own factories but has production offices next to the main suppliers. suppliers Benetton subcontracts labor-intensive activities but has invested y g p , heavily in controlling other production activities. On the other end, most stores are franchised Mango does not own the stock at the stores (same as Benetton) but does allow merchandise returns d ll h d
Achieving Shorter Lead Times
Source: Zara: Fast Fashion HBS Case 2003.
Short lead ti Sh t l d times enable quick response to fashion trends bl i k t f hi t d but short lead times are (usually) achieved at a higher cost
Selling at an Affordable Price

If procurement costs are higher, how can a Fast Fashion retailer still sell at an affordable price ? affordable price?
Short lead times / Small batches Frequent assortment q changes Increase visits to stores
Sales increase
Revenues increase
Better forecasts Two-way information flows (POS, store managers) Minimize underage & overage costs
Less and smaller markdowns
2008 Felipe Caro
Fast Fashion, Retailing Panacea?

Does quick response guarantee superior performance?
World Co. Time to Market Net margins ( ) Overhead (% Revenue) 2-5 weeks 2% 40% Zara 2-5 weeks 10% 20%
Source: Zara: Fast Fashion HBS Case 2003.
I F t F hi a groundbreaking innovation? Is Fast Fashion db ki i ti ?

Debatable, but for sure it is a self-reinforcing system based on: 1) closed loop communications 2) rapid timing and synchronicity 3) appropriate capital investments to increase supply chain flexibility
Fast Fashion Open Questions

Is Fast Fashion a retailing fad? Remember Benetton? Should every retailer adopt the Fast Fashion business model? b i d l? Zara-H&M rivalry. What is the right balance y g between basic and fashion items? How much can a Fast Fashion grow?
Mature market Will it work in the U.S. and China? Are the operations scalable?
2008 Felipe Caro
Motivation


Conclusions
Inventory Management of Zaras Retail Network

Objective Develop and measure the impact of an optimization model that supports the inventory allocation decisions in a large retail network August 2005 June 2007
Timeline Results
34% sales increase Less stock outs More time on display M ti di l Less transshipments
Deployment Status
Used to ship all items to all stores worldwide
2008 Felipe Caro
Zaras Supply Chain (2006)
Suppliers pp
2 shipments/wk 24 - 48h transit backroom display
70% Europe 30% Asia
2 warehouses:
Arteixo and Zaragoza
900 Stores:
45.4% 37.3% 10.5% 6.7%
Spain R. Europe America R. World
Source: Zara, Columbia Business School Case, 2002. Caro and Gallien (2007)
2008 Felipe Caro
Former Inventory Allocation Process

store inventory assortment decisions
Issues:
Store i incentives ti information resources
store managers
inventory y in stores, past sales
requested shipment q q p quantities for each reference and size
warehouse inventory
warehouse allocation team
Warehouse resources decision rules
shipments
( ) (a) Former Process

Brief Literature Review

Inventory management in distribution systems w/random demand (1 warehouse, N retailers): ( , )
Eppen and Schrage (1981): depot does not hold inventory Federgruen and Zipkin (1984): several approximations Erkip et al (1990): correlated demand McGavin et al (1999): impact of balancing retailer inventories
Salient features or Zaras problem:

Lost sales and holding cost is irrelevant Finite horizon with no re-ordering (only allocation) Dependencies across sizes
Literature on fast-fashion retailing:

Cases: HBS (3), Columbia, Georgetown/Warwick/Sevilla Caro and Gallien (2007)
2008 Felipe Caro
Proposed Allocation Process

assortment decisions store inventory assortment decisions store managers input forecasting model d l past sales data
store managers
inventory y in stores, past sales
requested shipment q q p quantities for each reference and size
warehouse inventory
inventory y in stores
demand forecasts
warehouse inventory
warehouse allocation team
optimization model
shipments
shipments
( ) (a) Former Process

( ) (b) New Process Envisioned

2008 Felipe Caro
Proposed Allocation Process

assortment decisions store managers input past sales data
Maximize: Global Revenues By Changing: Shipments Subject to: Inventory Availability y
forecasting model d l
inventory y in stores
demand forecasts
warehouse inventory
optimization model
shipments
( ) (b) New Process Envisioned

Inventory To Sales Function

Expected store sales for reference th t week f f that k
Expected Demand p or Max Sales Capacity
Stock of reference in store at beginning of week

Store Level Display Policy

Not all combinations of sizes are displayed:
Sales vs. brand perception vs Key to inventory distribution
remaining sizes
S M L S M L M L S M M S L S L
action
Keep on display Keep on display Keep on display Keep on display Keep on display Move to backroom Move to backroom Move to backroom
2008 Felipe Caro
Store Level Display Policy: Validation

Adherence t Major Size Display Policy Adh to M j Si Di l P li
50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
F Fraction of Stores
DPF/DPA (%)
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Final MIP Formulation
warehouse inventory constraints
approximate inventory-to-sales function
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Implementation
Forecast development p
Model development and integration with IT systems y
Pilot test
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Pilot Test: Objectives

Prove concept feasibility through actual implementation i l t ti Refine software interface and model f fi f i f d d l features based on feedback from real users Estimate the models specific impact on the inventory distribution
How to measure improvements?

Pilot Test: Metrics

Back to basics: newsvendor framework
Sales = min{ Shipments, Demand }
Sales / Shipments (S/S):

Shipments success ratio Less overstock S/S closer to 1
Sales / Demand (S/D):

Demand cover ratio Less understock S/D closer to 1
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Pilot Test: Distribution Performance Matrix

not enough inventory everywhere
High Sales / Shipments = Shipments Success R i S Ratio Low
ideal situation
too much inventory in low-selling stores, not enough in high-selling stores
too much inventory everywhere
Low
High
Sales / Demand = Demand Cover Ratio

Pilot Test: Estimating Demand

Censored information: sales are observed, not demand E Example: l
Weekly replenishments Initial stock = 8 units Item stocks out before next order is placed
Demand
Mon Tue Wed Thu Fri Sat Sun
8 units 7 day
Demand D d
8 units 3 day
Mon
Tue
Wed
Thu
Fri
Sat
Sun
2008 Felipe Caro
Pilot Test: Estimating Demand

For each size/store/week, we calculate:
Days when stock is not exposed (DSE) = days in which that size stocks out, or one of the major sizes stocked out and no sales were observed If Sales > 0 and DSE < 7: Demand = Sales x (7/(7 DSE)) (7/(7-DSE)) If Sales = 0 or DSE = 7: Demand = most recent demand (otherwise, zero)
Finally, we aggregate demand across all stores and references

Pilot Test: Design

The model was only implemented at warehouse in Arteixo The warehouse in Zaragoza was used to validate the methodology We collected sales and shipment data, before and after the data model was introduced The analysis is based on 10 references, 4 basics y 6 y , fashionable (for the rest there was not enough data)
2008 Felipe Caro
Pilot Test: Methodology to Asses Impact
Objective
Estimate the impact of the model on the distribution performance metrics We W cannot observe the t b th counterfactual (what if the model had not been used) Control Group + Difference-in-differences
Problem
Solution
Slide courtesy of Shanna Rose
2008 Felipe Caro
Pilot Test: Control Group

For each reference in the pilot, we identify a control reference using the following matching criteria: f i h f ll i hi i i
Basic with basic, fashion with fashion The dates when both references were introduced differ at most in one week We minimize the difference in performance (measured by the S/S and S/D ratios) the week before the allocation model was introduced (i.e. int od ced (i e the sta ting point must be the same) starting m st
W repeat the process for the same 10 references in We t th f th f i Zaragoza
2008 Felipe Caro
Pilot Test: Difference-in-Differences

Pilot Start Pilot Reference Control R f C t l Reference PS CS Pilot End PE CE
Specific Model Performance Impact: S ifi M d l P f I t

Removes anything that happened before the pilot
(PE - PS ) - ( CE - CS )
Removes anything that happened during the pilot but is not due to the model
2008 Felipe Caro
Pilot Test: Example, Reference XXX/YYY/250

Metric S/S XXX/YYY/250 (pilot) XXX/YYY/800 (control) Pilot Start: week 33 37.4% 30.1% Pilot End: week 46 78.3% 65.2%
Specific Model Performance Impact:

Removes anything that happened before the pilot
(78.3% - 37.4% ) - ( 65.2% - 30.1% ) = 5.8% (

Removes anything that happened during the pilot but is not due to the model
Pilot Test: Arteixo vs. Zaragoza
A larger fraction of what is sent is actually sold A better match between supply and demand Overall, total sales increase by 3-4%! , y
Pilot Test: Increase in Sales
2008 Felipe Caro
Pilot Test: Other Metrics

Returns / Shipments (R/S): returns & transshipments ratio
Store Cover (SC): proportion of sizes x days x stores with stock
Display Cover (DC): proportion of sizes x days x stores on display
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Pilot Test: Additional Results
Less returns and transshipments Less stock outs More time on display
Full Scale Implementation: Estimated Impact

Full scale model implementation: 1st half 2007
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Full Scale Implementation: Impact on Net Margin
Source: Inditex Annual Reports
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Whats Next Clearance Pricing Optimization
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Zara avoids price promotions during the regular selling season. New challenge: how to estimate price sensibilities?
Parameters Parameters Parameters Parameters Parameters Parameters
Historic Data
Predicted
Parameters Parameters
Current Season
2008 Felipe Caro

Optimization model: apparent temperature is more important than the actual one one Most relevant metric:
% Markdown =
Revenue Clearance Sales Initial Stock ($)
Valued at regular season prices
Current project status:

Prototype implementation ready , g Pilot test: 3 countries, 4 categories First pricing decisions are being implemented today!
Motivation


Conclusions
Conclusions
Key lessons from Academia-Industry collaboration
Main obstacles: lack of data & internal barriers Need project champion and clear metrics Initially, expect results to confirm intuition up to 90% t a y, e pect esu ts co tu t o Retail is detail: behavioral aspects matter (e.g. store level dynamics), but remain focused
High impact application of Operations Research

Direct impact on p p profits Scalable system that enables growth
Fast fashion is successful because it competes with (and not in spite of) operations

The Fast-Fashion Business Model: O D H C An Overview Based On The Zara Case

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The Fast-Fashion Business Model: An O Overview Based on the Zara Case d h C

Taller "Rocket Science" en Retail 2008, Santiago, 19 de Junio g ,

What is Fast Fashion?

Research Collaboration with Zara

Motivation: Recent Brand Value Data

Source: BusinessWeek / Interbrand (2007)

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Zara and the Fast-Fashion Strategy

Top Global Brands 2007 p 2

Source: BusinessWeek / Interbrand (2007)

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Zara and the Fast-Fashion Strategy

Source: BusinessWeek / Interbrand (2007)

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Zara and the Fast-Fashion Strategy

Source: BusinessWeek / Interbrand (2007)

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Zara and the Fast-Fashion Strategy

Source: Interbrand (2008)

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Motivation: Fast-Fashion Assortment Rotation

Fast-Fashi ion Retai iler

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

What is Fast Fashion?

Research Collaboration with Zara

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Fast Fashion Operations Strategy

Infrastructural choices (intangible software) (intangible, software )

The Fast-Fashion Business Model: An Overview Based on the Zara Case

Two Examples of Fast-Fashion

97% outside U.S.A.

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Two Examples of Fast-Fashion

1 SEK = 0.107 1 US$ = 0.65

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

H&M The Gap

Achieving Shorter Lead Times

Source: Zara: Fast Fashion HBS Case 2003.

Selling at an Affordable Price

Less and smaller markdowns

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

Fast Fashion, Retailing Panacea?

I F t F hi a groundbreaking innovation? Is Fast Fashion db ki i ti ?

Fast Fashion Open Questions

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro

What is Fast Fashion?

Research Collaboration with Zara

Inventory Management of Zaras Retail Network

Used to ship all items to all stores worldwide

The Fast-Fashion Business Model: An Overview Based on the Zara Case

2008 Felipe Caro