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The Zara Gap: Value and Values

Rana Plaza, where 1,129 factory workers died in Bangladesh in April 2013, was expected to become a turning point, just as Exxon Valdez and the Triangle Shirtwaist Company were other momentous disasters that catalyzed social and business change. Yet, two years later, sweeping change has not happened and the apparel industry has not galvanized itself beyond inspections to address labor, government and management failures.

Privately, industry people lament the episode, recognize the human tragedy, yet point out that the country’s production orders and export volumes have actually increased. Surely, Rana Plaza represents the high cost of lowest cost industry strategies, and they continue.

Of all the meta-forces in our lives, none is more relentless than globalization, and the front lines are textiles. Its impacts occupy media, academics, politicians, business, NGO’s, activists and consumers. Experts and pundits attempt to fathom how its inevitable forces affect labor rights, sustainability and economic development. On these important subjects, there is a consistent theme across analysts and participants.

In academia, Michael Spence at Stanford led a global study on developing countries and argues: “The Growth Report kills off once and for all the misguided notion that you can lift people out of poverty in the absence of growth.” At MIT’s Poverty Action Lab, economist Esther Duflo explains, “When it comes to the world’s poor, what they want is a job.” Rick Locke, at Brown University, describes himself as “disappointed” at the slow pace of improvement after studying industry practices related to labor and environmental issues for the past decade.

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The textile industry, that ancient provider of comfort and covering, is our School for Globalization. Few industries reach and connect nearly every country, worker and consumer with the same products and distribution. Its decidedly low tech manufacturing was among the first industries to globalize in a long arc of disruption from India’s artisans to England’s mechanization of the same cloth; and from New England and Southern factories to Asian contractors offering lowest costs. Indeed, a great deal of the economic research on manufacturing migration and job displacement draws upon the historical data of textile-related economics.

Is a textile story a good basis for a social business model? The history of a Spanish company, Inditex, suggests that it is.

Inditex is a retailing company with multiple store concepts and brands but it is best known for Zara and “fast fashion.” If you are even remotely connected with retail trends you know the influence of this company as an unconventional purveyor of apparel that is both affordable and fashionable. Zara’s fast fashion performance is often cited as the foremost alternative to the relentless price intensity of Walmart and Amazon, and to the ultra-high image marketing of the luxury brands. Zara, indeed, has the attention of both competitive channels for its ability to perform in a high risk business yet sharply reduce its exposure to uncertainties of unwanted inventory, markdowns and stockouts.

Inditex is located in Northwest Spain, in La Coruna, as unlikely a place for retailing success as Bentonville, Arkansas. The founder, Amancio Ortega, was a wholesale manufacturer who – to avoid losses from cancelled orders – became a retailer to manage excess inventory. He maintained control over capital for making fabric but contracted home sewers for the labor-intensive requirements of finishing garments – small lot, outsourced and highly flexible manufacturing.

One of his main goals was to create jobs in this remote, depressed area of Spain, once the home to ship building and heavy industry, long since superseded. Necessity to reduce risk and capital requirements led to flexibility through networked but tightly managed contractors. The network was built on trust, shared mission and growth. The company’s commanding success (Ortega is No. 4 among the world’s wealthiest) may lead us to forget the original circumstances of survival, unemployment and scarce capital. In an authorized biography published in 2008, Ortega told Covadonga O’Shea, onetime director of Spain’s fashion magazine Telva, “My university was my profession. I wanted to be a different kind of impresario, one with a social conscience.”

What lessons might be drawn from Zara? While its culture is unique, its business processes are not. Their superior performance is worthy of industry study and envy, but the core of their capability is supply flexibility, often known as “postponement” in industries such as electronics. Postponement is compelling in fashion retailing due to its high degree of inefficiency from concept to consumer, a 12-month cycle for most competitors. What other industry can produce its product for a few dollars, mark up initial margin to 60-70 percent, and then gather in gross margin at or near 40 percent? What happens to the rest is a cushion of inefficiency. The average net income for apparel retailers is low-single digits, while Zara captures a consistent 16 percent return on sales, so what sells on Main Street matters on Wall Street.

The difference between initial and final margins is largely the cost of markdowns and stockouts, an average of 33 percent industry-wide. That disparity is the cost of demand uncertainty, aggravated by long lead times, forcing product commitments too far in advance to forecast accurately. To allow sharp closure of that gap between inventory commitment and sale, a difference of months to days, retailers are adapting postponement, or supply flexibility. In industry research and case studies on retail supply chains, Stanford’s Warren H. Hausman and I have deconstructed and quantified the financial benefits of supply flexibility, captured here in a “Zara Gap” analysis:

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The Zara Gap is good news. For apparel and footwear alone, an estimated $300 billion in losses per year (in a $1.2 trillion industry) may be recaptured via speed-to-market capabilities that match lead times to selling seasons. Productivity in apparel retailing is being accelerated by the availability of data tools and algorithms for global management, the expectation of investors to match the results of international retailers, and the ultimate vote of customers who demand fashion trends and transparency.

Is productivity purely profit enhancement? Perhaps it is, but that would be the wrong answer to challenges of both competitiveness and sustainability. Lowest cost sourcing and exploitation of lowest wage countries are outdated strategies, mismatched to rising Asian sourcing costs, e-commerce visibility and global consumers driven by trends delivered in shorter and shorter merchandising cycles. And, to appeal to millennial customers (ages 15-35), brands want to reflect ethical values as a part of a company’s product image, a fact acknowledged by Starbucks, Nike and others that are embracing transparency as part of closer collaboration with factory and worker communities. Rick Darling of Li & Fung observes: “L&F is a low-cost company. We move from country to country to create deflation of apparel prices. We believe that is over. Today, sustainability is just as important as product price and quality – maybe more.”

Nancy Koehn of Harvard Business School, says, “There are millions – soon-to-be billions– of consumers, voters and other actors, most obviously ‘Millennials,’ who want something new from business, who conceive of business and the ‘flywheel’ of global capitalism in ways distinctive from their counterparts in the past. These actors will exert great power in the next two decades.” No wonder, then, that Millennials collectively favor companies that embrace the values of good citizenship, according to a recent New York Times article. It cited a Brookings report as saying Millennials overwhelmingly “responded with increased trust (91 percent) and loyalty (89 percent), as well as a stronger likelihood to buy from those companies that supported solutions to specific social issues (89 percent).”

Industry-wide disruption is no longer speculation, but rather reflective of multi-sector experience from autos to electronics. “Any CEO who thinks his or her job is primarily about maximizing shareholder value is living in the past,” Koehn says. “The game of what kind of capitalism will define this century has changed very quickly and dramatically.”

Michael E. Porter, also of Harvard, offers his prescription for innovation as “Creating Shared Value,” the new economic relationship of business to its communities as an engine for growth. Porter defines shared value as policies and operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions between societal and economic progress. He writes, “Creating shared value is integral to a company’s profitability and competitive position. It leverages the unique resources and expertise of the company to create economic value by creating social value.”

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In the aftermath of Rana Plaza, textiles remain symbolic of goals for economic inclusion and opportunity. Given fashion ubiquity and rich possibilities for productivity in this most global of industries, the formula for supply chain innovation is supply flexibility + shared value = social impact. Today, the tide of change driven by fast fashion, e- commerce, and “wearables” integrating apparel with electronics is overwhelming deeply rooted, adversarial practices of lowest prices, highest volumes and longest lead times. New technology for speed and flexibility means that consumer value and values can co- exist. In leadership for globalization, the fashion model matters.

John S. Thorbeck, Chairman of Chainge Capital LLC, is an expert on the application of Fast Fashion business principles at retailers and brands. He has collaborated extensively with industry leaders, including Warren H. Hausman, professor of management science and engineering, Stanford University. Thorbeck is a former CEO of Rockport (Adidas) and G.H. Bass & Co. (PVH), and senior marketing executive for Nike, Timberland and the Aspen Skiing Company. He is a graduate of Harvard Business School.