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The Zara Gap: Retail’s Big Arbitrage

Retail globalization today means rising sourcing costs and complexity, labor and wage volatility, e-commerce growth and highly uncertain consumer demand—each a major challenge to existing supply chain management. Warren Buffett, reflecting on the lagging performance of retail companies, which are 10 percent of his portfolio, observes “seismic technological change,” driven largely by dynamic competitors that master supply chain logistics, like in the U.S. and elsewhere.

Executives face intense lead time and operations challenges in any sector that is trend- driven: apparel, footwear, toys and electronics. With these industries in mind, the “fast fashion” business model reflects consumer and cultural changes, and dramatically improved financial results. Process innovation, like supply flexibility, applies broadly to softgoods and to categories of merchandise that include cell phones, iPads, and even “wearables” which are integrating apparel and electronics. And what global product today is not trend-driven?

To achieve the business value of supply flexibility for trend-driven companies, we describe how “postponement”—transforming a product into its final form at the latest moment possible—is the key strategy.

The “Zara Gap” opportunity

Pioneering research by Dr. Warren H. Hausman, professor of management science and engineering at Stanford University, on sequential decision-making for style goods in which forecasts can be revised so that demand uncertainty is a function of the forecast horizon, was the earliest model of non-stationary demand in production problems. That management challenge has exploded in importance, as retailers and brands adapt its principles to fashion’s complex products, economics and cultures. Hausman’s work has made it possible to quantify the financial value of supply flexibility to reduce unwanted markdowns and lost sales, or stockouts. As a result of this research, a promise of exceptional business value has emerged for retailers, brands and suppliers that adopt postponement techniques from electronics and other industries. Hausman documents through financial analysis that supply flexibility (or postponement) in retail can achieve the following:

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  • Increase profits by as much as 28 percent
  • Increase market capitalization by as much as 43 percent. To draw these conclusions, Hausman analyzed public data available from 53 retail and short-product lifecycle businesses. The research illustrates the “Zara Gap,” so-called because of Zara’s ability to vastly outperform category averages for department stores, wholesale brands, specialty retailers and athletic brands:

The "Zara Gap" Chart 1

Hausman says that the performance at Zara, the Spanish retailer long known for its fast fashion leadership, and other European and US retail categories, suggests despite industry investment in demand management and generation, a significant “opportunity gap” remains. The most powerful lever to improve markdown/stockout performance is a combination of business process and analytics for supply flexibility, he says.

In financial terms, the Zara Gap is “the big arbitrage,” since it is too large and too dynamic to separate one competitor from its industry for long. Zara’s outsized performance, as captured in its parent company’s market capitalization, is a prominent example that the battlefield today is shifting to total supply chain performance.

“Supply chain performance refers to the extended supply chain’s activities in meeting end-customer requirements, including product availability, on-time delivery and all the necessary inventory and capacity in the supply chain,” according to Hausman. He also emphasizes that supply chain performance crosses company boundaries, as well as traditional functional organization lines.

Global products are trend-driven

Because demand for short-life-cycle products or fashion goods is extremely hard to forecast, retailers and brand owners chronically suffer from costly markdowns (price reductions to move merchandise unsold at full price) and stockouts (lost sales due to sellouts of popular styles). Estimates of the costs of markdowns alone range widely, some as high as 33 percent of retail sales.

By contrast, Bain & Company estimates that companies employing “fast fashion” tend to have significantly lower markdowns (both in items and in magnitude of markdown) than other classes of retailers. This point is illustrated (below) in a Bain & Co. comparison of markdowns for Zara.

Typical markdowns across retailer categories:

The "Zara Gap" Chart 2

Markdowns and stockouts exact a heavy toll at fashion companies. In trend-driven goods, selling seasons are short, new product development lead times are long, demand uncertainty is high, and the risk and impact of stockouts and markdowns are very high.

What is fast fashion?

Fast fashion is a business model tailor-made for the multi-channel “I want it now” Internet-driven buyer of today. It offers significant business value to a range of retail companies whose product cycles are accelerating and influenced by celebrities, luxury brands, and media hype. The long and guarded industry process of translating fashion design into street wear—or from elite runway shows to department store floors—is now completely transparent to sophisticated “fashionistas,” young people whose purchase influence is 24/7 mobile access to stores, stars and sources that truly reflect demand- driven impulses.

Accordingly, fast fashion supply chains are different, characterized by significantly shorter cycles from design to delivery, often in three to six weeks. Frequent new product flows that move away from traditional two to four seasons per year, intense focus on style-color depth instead of product line breadth, product as traffic driver rather than advertising, and a sourcing mix for flexibility and speed versus cost alone also characterize fast fashion supply chains.

The fast fashion phenomenon is redefining both sales and profit opportunity by focusing on the immediate question: how quickly can product design trends be correctly translated into multi-channel mass product?

To respond, the new product engine is primarily, though not exclusively, driven by supply flexibility which links upstream inventory commitments with a brand’s downstream profitability (full-price sales, markdowns, stockouts, and unwanted inventory). Its critical elements are:

  • Postponing finished good commitments to reduce lead times and finished goods inventories
  • Staging capacities and hedging materials to exploit improving forecasts during the selling season
  • Optimizing total profit to incorporate financial impacts of markdowns, stockouts and unwanted inventory versus focus on cost minimization alone
  • Integrating demand for fresh, more frequent new product with rapid replenishment

Postponement is a well-known concept in supply chain management, although its successful application in fashion companies is rare.

The goal of postponement is to delay, to the latest time possible, the transformation of a product into its final form as a specific stock keeping unit (SKU) in style, color and size. The idea is that delaying the point of product differentiation will enable the manager to tailor SKU assortment as closely as possible to rapidly shifting store or online demand.

Walmart has recently applied a variation of postponement strategy to its television and bicycle businesses, heretofore manufactured 100 percent in China. By shipping components for final assembly in the U.S., Walmart enhances flexibility and is closer to buying patterns in its stores. The cost differential is 10 percent, more than compensated by in-season sales performance, and even that differential in China costs is expected to equalize by 2017. In volume commodity categories, Walmart sees that speed and flexibility trump lowest costs and adds a promotable Made in USA benefit.

Closing the “Zara Gap”

Today, most consumer products—apparel, footwear, electronics, toys, entertainment and home furnishings—are trend driven. For most of the past 25 years, retailers and brands have exploited lowest-cost sourcing and distribution efficiencies. The rise and dominance of discount, value retail and outlet channels reflects price-driven competition and excessive inventories.

Recently, however, specialty retailers like Zara, H&M and Uniqlo have combined low cost (but not necessarily lowest cost) with product speed and flexibility. These retailers compete on quick-to-market design capability and adherence to a “buy now, gone tomorrow” approach to inventory and sales traffic. The result creates a “seasonless cycle” of fashion, as Anna Wintour, editor-in-chief at Vogue Magazine, presciently forecast years ago

Retail’s “big arbitrage” is significant. That is, to close the untapped economics in the “Zara Gap” or remain a lagging fashion and financial follower. While many retailers excel at low cost sourcing and warehouse-to-store distribution, the unexploited management area is to master product speed, cost and flexibility across the entire enterprise supply network. In an era of seismic technological change, the financial imperative of the “Big Arb” is a rapidly transformed and collaborative supply chain. In leadership for global retail, the business model is fast fashion.


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.