In June, Inditex SA, Zara’s parent company, announced it had demonstrated an 18 percent surge in net profit and a 14 percent jump in sales in its latest quarter. That’s a very sharp contrast with the major retrenchment many of the leading retailers have been undergoing over the last 15 months. And why are they driving the fast fashion bus? The old merchant industry model, built on low cost, volume sourcing, a very slow, front-end product decision-making process that is hierarchical and measured by cost and control is being “completely outgunned by low (but not lowest) cost, and frequent and fresh assortments that drive seasonless traffic flow,” in the words of John Thorbeck, chairman of Chainge Capital LLC.
For the last 35 years, until 2001, the world of supply chain management was driven by what we call “The Push System.” This approach involves planning production based on a required schedule in advance of customer demand and driven by a forecast. It also involves a distribution system for replenishing field warehouse inventory on a regular and calculated basis. This approach became much more sophisticated in the 80s and 90s, migrating into what we call DRP, Distribution Requirements Planning. This method consisted of determining the need to replenish inventory at branch warehouses. A time-phased reorder point approach was used to trigger the planned orders at the branch warehouse level back to a manufacturing site, who would push a “Fair-Share” allocation quantity out to the branch. The Push approach led to much more supply chain complexity due to more and more distribution centers feeding more warehouses that were close to customer regions in order to improve service and delivery.
Since 2001, when the Internet was introduced and became ubiquitous, “The Pull System,” or Demand-Pull approach, has been making inroads across multiple industries. In a Pull system, procurement, production and distribution are demand-driven rather than by a forecast. This approach follows the “supermarket model” where limited inventory is kept on hand and is requested as it is consumed. Another attribute of Pull is a supply chain where a customer purchase initiates real-time information flows through the supply chain that consequently causes movement of product through the network. And one further differentiation is utilizing Just-in-Time (JIT) methods. This involves—Zero Defects, Reduced Lead Times, Reduced Setup Times and Smaller Production Run or Lot Sizes. The net-net is: This supply chain approach concentrates on demand pull rather than supplier push inventory models.
The PUSH vs PULL inflection point
As profiled in the chart below, until about 2001, the rationale was assets are king. The more inventory you had, the better your service levels could be and professionals were paid based on their total assets. With this came “Economies-to-Scale,” which meant large production runs to drive down unit costs and make-to-stock inventory driven by forecasts of demand.
The problem, as described by Paula Rosenblum, managing partner at RSR, in Apparel Magazine, is: “Many apparel companies are still chasing the lowest cost, which tends to be the farthest from the point of demand/sale…When you buy in large slugs from far-off places, you’re placing very large bets. And if you’re ridiculously wrong, there’s not much you can do.”
Then, the Internet was born. Computer company Dell was one of the first to change the customer experience, using the Internet, allowing customers to order and configure their own PCs online, pay online with a credit card and have it delivered in three days. Dell also completely stopped producing costly/risky finished goods. It utilized the postponement technique to reduce finished goods inventory and maximize its cash conversion cycle. Big box retailers then picked up on the Internet to drive Demand-Pull supply chains and pull product through their networks. Why? Because they figured out that information can be more important than inventory and supplanted inventory with information. A seminal change!
As Lee Peterson, EVP of WD Partners, said in Retail Technology magazine, “Seismic shifts are continuing with the retail customer. Retail is at the peak of the most dramatic shift it has likely seen since the late 90s. If the late 90s was the inflection point for many industries, 2015 was probably the year retail finally realized it!”
The compelling reason to act
The Zara Gap model measures the fast fashion retailer against the traditional retail sector using 1) market cap/revenue and 2) operating income/inventory. We know that the two metrics of success used today in retail are operating margins and gross margins. These two are impacted by the way in which the supply chain is designed and executed.
Zara has designed a supply chain that mobilizes the financial metrics of speed and flexibility, valuing both over cost. This working capital model allows it to source and sell with lower risk and investment. Therefore, with its Demand-Pull supply chain model, Zara’s profitability is unparalleled, capitalizing on high margins without high markdowns.
As Ashesh Amin, COO of women’s wear company Adrianna Papell, said, “The exciting opportunity for apparel companies will be to embrace Demand-Pull approaches in an effort to leverage their supply chains to improve profitability.”
Gregory L. Schlegel, CPIM, CSP, Jonah is the founder of of the Supply Chain Risk Management Consortium at Lehigh University, a group of 19 companies that focus on SCRM education and body-of-knowledge, risk identification, assessment/quantification, mitigation tactics, business continuity planning, enterprise risk management, supply chain cyber threat analysis, supply chain mapping and more. Schlegel can be reached at Grs209@lehigh.edu
Please join the consortium at the upcoming one-day “Risk and Supply Chain Management: Preparedness for the Global Sourcing Fashion Business” event at LIM College, in New York on September 12to learn more about supply chain strategies, execution, the impact on the bottom line along with profiling the traumatic transformation the retail industry is experiencing. We’ll discuss the “ZARA GAP”, new financial models, such as Cash Conversion Cycle, several trends in the retail industry and performance drivers such as Risk Appetite, Risk Tolerance, Supply Chain Agility, Resiliency and Profits. Register here.