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Vertical Integration vs Outsourcing

In: Business and Management

Submitted By cdrmujib
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Vertical Integration vs Outsourcing of Zara
Written by

Mohd Rahman
October 04, 2014

“The original business idea was very simple. Link customer demand to manufacturing, and link manufacturing to distribution. That is the idea we still live by” -- Jose Maria Castellano Rios, Inditex CEO.


Introduction to Zara
Zara is an icon in the fashion world and largest international fashion designing and manufacturing company. Zara is the flagship chain store of Inditex Group owned by Spanish tycoon Amancio Ortega, Inditex is one of the world's largest fashion retailers with eight brands and over 6,460 stores throughout the world (Ref-1). Headquarter of the group is in Coruña, Spain where the first store of Zara was launched in 1975. This paper will analyse the company and try to link its activities with supply chain strategy of vertical integration and outsourcing. Later will come to a conclusion that Zara is vertically integrated with justification and made recommendation for further improvement. Definition of Vertical Integration In strategic management, the term vertical integration describes a style of management control, when a company expands its business into areas at different points of the same production path. Vertically integrated companies in a supply chain are united through a common owner. Usually each member of the supply chain produces a different product or services, and the production combine to satisfy common need. In the following paragraph I will try to highlight the organization and decision-making process of ZARA in short

Brief Organization and Decision-Making Process of ZARA
The followings are the most critical factors of Zara’s operation: Decision Making: The decision making process is based on judgement of employee instead of relying on small set of decision makers; the majority of decisions are made by store managers and designers Target market: Zara’s target market is very broad because they do not define their target by segmenting ages and lifestyles as traditional retailers do. Zara’s


target market is a young, educated one that likes fashion and is sensitive to fashion Procurement : Establishing merchandise sources, policies and practices. Retail Environment: Zara’s managers and sales associates are in charge of transmitting the sales analysis, the product life cycles, and the store trends to the designers. This allows the designers in Spain to develop the right products within the season to meet consumer demand Speed & Decision Making: Zara responds quickly to demands. Store managers have more authority than other stores such as deciding the garment to be put on sale. ‘Commercials’ decide which garments to be produced & sold. Have great deal of autonomy as higher management doesn’t second guess their decisions Ordering & fulfillment: Manual inventory management based upon direct

observation & store manager judgment, Use of PDA’s, Infrared, dial-up modem for order management, Process is complicated & divided in various steps such as breaking order into segments and beaming these segments to concerned person who then filled up their part Design & manufacturing: Maximum time from conception to distribution centre is three weeks. Prices and services: Zara product price is affordable , provides prepurchase service, postpurchase service, ancilary service. Store atmosphere : Zara store’s are identical and designed by own team, stays update through the website. Marketing, merchandising & advertising: Zara is broadly and deeply assorted. Very low spending on marketing (Only .03%) while heavy spending on stores, No


‘classics’ clothes but clothes with very short lifespan forcing customers to buy it on the spot, visit stores often Location and distribution : Zara locates themselves in central business

districts with as many outlets as possibe. Zara has centralized distribution facility, It’s internally or externally produced merchandise goes to the distribution center. Centralized control helps to, avoid misunderstanding or conflicts, time scheduling, focused on one rather than managing several different time schedules. Online: 26 Online markets, own information technology team, presence in newsletter, face book, instagram, twitter, pinterest, YouTube, apps (Ref: Human Resource: Zara has a well motivated team that work exclusively to achieve goal. Only one staff left the job in 10 years. Information Systems at La Coruna, Factories, and Stores & DC’s: Accelerated IT software to transfer spesific communication and design”. Main features are: • • • • • • • Several IT systems are used to prepare orders, distribute them over internets & collect them Factories had simple applications which provided information about order & due dates Distribution centre had largest automation with complete tracking of SKU’s Stores used PDA’s which communicate to La Coruna via modems PDA’s were upgraded constantly while POS terminals remained same for over decade! POS used DOS as operating system & its installation & maintenance was very simple No real time feedback from stores to Zara’s headquarters


• •

Transmission required copying into floppy disc & then sending it using internet which happened at the end of the day No dialogue between PDA & POS inside store or between two stores

ZARA Business Model VS H&M: H&M, a Swedish clothing firm does everything through outsourcing. H&M doesn’t own any factories; instead H&M buys clothes and other items through an abundance of detached suppliers. On the other hand the business model of Zara is vertically integrated. Zara controls every step of the value chain; only clothes with a longer shelf/fashion life time are outsourced. Answer for Questioners - 1 It is not easy to find “only the best way” in this changing world. From the definition of vertical integration, I am sure that Zara has adopted itself vertically to a high degree. To govern the company Zara used its capabilities and resources through a carefully chosen strategic control and risk management techniques with effective coordination in all level. Because Vertical Integration worked as the main driving force behind the above success story of Zara. Answer for Questioners - 2 Decision making structure of Zara is flat. Decision making is decentralized which allow Zara to respond quickly to the changing market change and meet the customers’ needs. Low level decisions are also integrated to make higher level of decisions in Zara. The decision making process is based on judgement of employee instead of relying on small set of decision makers; the majority of decisions are made by store managers. Fast Fashion and production is the critical success factor for Zara. This indicates that Zara’s situation completely supports their supply chain strategy. Answer for Questioners – 3 Before answering the question of this section I did a supply chain process mapping and SWOT Analysis of ZARA as follows:



SWOT Analysis of ZARA. Strength: Vertical integration , high brand image and value, strong distribution channel, spot emerging trend and react quickly, inexpensive but fashionable, customers ‘comments and feedbacks, effective communications , product development, business efficiency, own information technology team, 26 online markets, presence in newsletter, facebook, instagram, twitter, pinterest, youtube, apps ( Ref:

Weakness: Does not advertise, weak online presence, centralized distribution system, low outsourcing Opportunities: Online market, expansion plan, outsourcing, growing apparel market in Asia
Threats: Euro centric production, threat of new entrants, economic recession, global and local competitors, no advertising campaign, market entry barriers by governments

Recommendation: On the basic of SWOT and supply chain process mapping analysis it can be easily understood that Zara is properly organized to vertical integration. However following change and strategies are recommended: a. Zara has started online market from 2010. Till September 2014 it has open 26 markets online. Zara should consider availing the opportunities, drive away weaknesses and reduce the threats as mentioned above. b. Vertically integrated supply chain ensured constant introduction of new items with short lead times. Based upon commercial’s guess this need not be accurate c. Although the existing system is working fine, Zara has been recommended to upgrade its POS system in order to cope with future changes. d. Introduce modern information systems to maintain the flaws prevailing in current Supply Chain, Customer Relations and Resources Planning. It has also been suggested to implement other Information Systems to make its performance more effective and efficient.


e. New style can appear very quickly and Zara needs to respond quickly to the demands of their fashion conscious customers. f. Designers needs to more and more creative so that it can maintain its competitive advantage to be “the fast fashion”. g. Should use robotic technology in the production line instead of keep using the old ones. h. Should make more distribution centres in the strategically located points so they will enable Zara to be more faster, effective, and efficient in distributing their products to the retailers. i. Shouls increase at least 5% of the revenue for advertising to counter its competitors as they are becoming more competitive and demands are declining.

1. Inditex Group 2. 3. 4. 5. Zara Online 6. Annual report 2013


1. Beside study material provided by course other documents, websites, annual reports were studied and main parts are attached in the following pages below:




Evolution of main indicators Turnover Sales (in billions of euros)

2013 16.724

2012 15.946

2011 13.793

2010 12.527

2009 11.048

Financial structure Net assets attributable to the parent company Net financial position (in billions of euros)

2013 9.246 4.055

2012 8.446 4.097

2011 7.415 3.465

2010 6.386 3.427

2009 5.329 2.380

Financial and management ratios ROE (Return On Equity) ROCE (Return On Capital Employed)

2013 27% 35%

2012 30% 39%

2011 28% 37%

2010 30% 39%

2009 26% 34%

Results Operating profit (EBITDA) Operating profit (EBIT) Net profit Net profit attributable to the parent company (in billions of euros)

2013 3.926 3.071 2.382 2.377

2012 3.913 3.117 2.367 2.361

2011 3.258 2.522 1.946 1.932

2010 2.966 2.290 1.741 1.732

2009 2.374 1.729 1.322 1.314


Other relevant information Number of stores Net openings Number of markets with commercial presence Number of employees

2013 6 340 331 87

2012 6 009 482 86

2011 5 527 483 82

2010 5 044 437 77

2009 4 607 343 74

128 313 120 314 109 512 100 138 92 301


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