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The Fast-Fashion Business Model: O d h CAn Overview Based on the Zara Case
Felipe CaroUCLA Anderson School of Management &
Depto de Ingeniería Industrial U de ChileDepto. de Ingeniería Industrial, U. de [email protected]
Taller "Rocket Science" en Retail 2008,Santiago, 19 de Junio
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
g ,
Presentation Outline
• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?
• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions
• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization
• Conclusions
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Motivation: Recent Brand Value Data
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Source: BusinessWeek / Interbrand (2007)
Zara and the Fast-Fashion Strategy
2007
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The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Source: BusinessWeek / Interbrand (2007)
Zara and the Fast-Fashion Strategy
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Source: BusinessWeek / Interbrand (2007)
Zara and the Fast-Fashion Strategy
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Source: BusinessWeek / Interbrand (2007)
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The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Source: Interbrand (2008)
Motivation: Fast-Fashion Assortment Rotation
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The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Presentation Outline
• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?
• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions
• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization
• Conclusions
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
What is Fast-Fashion?
• Business Strategy:gy
“Cutting-edge fashion at affordable prices”
• Operations Strategy: builds on Quick • 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 to t e autoindustry (Hammond and Kelly 1990)
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Fast Fashion Operations Strategy
• Structural choices (tangible, “hardware”)– High level of vertical integration (includes store ownership)g o a g a o ( ud o o p)– Tight control of production (either through ownership or
permanent monitoring)– Dual supply chain (SC):pp y ( )
Basic items: efficient SC (minimize cost)Fashion items: responsive SC (minimize lead time)
– Simple but effective IT systems p y– Modern distribution centers
• Infrastructural choices (intangible “software”)• Infrastructural choices (intangible, software )– Cross-functional decision making highly centralized– Fashion items produced in small batches
Frequent assortment changes trying to follow fashion trends– Frequent assortment changes trying to follow fashion trends– Daily information exchange with store mangers– Strong operations-driven organizational culture
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Two Examples of Fast-FashionZara (Spain) H&M (Sweden) The Gap (U.S.A.)
Vertical Integration (2007)
Fully integrated. Subcontracts cutting, sewing, and shipping
Controls of every link in the chain but does not own factories
From design to store but outsources production
No. of stores worldwide(2007)
1,361 1,522 >1,572
No. of Countries(2007)
68 28 21
Distribution of Stores - Main Locations
(2007)
13% North Europe60% South Europe
7% East Europe8% Latin America5% Asia Pacific
63.5% North Europe19% South Europe
5% East Europe12% North America
9% United Kingdom79% North America
7% Japan
Sourcing - Main Suppliers(2006)
34% Asia50% Spain & Prox. 14% Rest of Europe
>60% Asia<40% Europe
97% outside U.S.A.
Assortment Composition 40% Basic >70% Basic 99% Basicp(2006) 60% Fashion <30% Fashion
Lead Times - Dual SC(2006)
Efficient SC: 6 MonthsResponsive SC: 2-5 Weeks
Efficient SC: 6 MonthsResponsive SC: 3-6 Weeks
Efficient SC: 9 Months
Refresh Fashion Items Twice a week Daily Occasionally (2006)
y y
Pricing (2002)
Overall, higher than H&M (especially out of Spain)
Lowest among Fast Fashion Comparable to Zara, if not higher
Marketing Expenditure 0.3% of Revenues 3-4% of Revenues Comparable to H&M
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
g p(2002)
p
Source: Annual Reports and Public Press
Two Examples of Fast-Fashion
Inditex (Euro) H&M (SEK) Gap Inc. (US$)
Revenue (Net Sales) 9 435 78 346 15 763 2007Revenue (Net Sales) 9,4358,196
78,34668,400
15,76315,923
Gross Margin 56.7%56.2%
61.1%59.5%
36.1%35.5%
Operating (EBIT) Margin 17.5% 23.5% 8.3%
002006
Operating (EBIT) Margin 17.5%16.6%
23.5%22.4%
8.3%7.7%
Net Margin (ROS) 13.3%12.3%
17.3%15.8%
5.3%4.9%
Working Capital /Sales -6.1% 9.7% 10.5%Working Capital /Sales 6.1%-6.1%
9.7%10.2%
10.5%17.3%
Inventory Turns 4.064.36
3.833.84
6.395.72
Asset Turnover 1.33 1.88 2.01Asset Turnover 1.331.43
1.881.92
2.011.86
ROA 17.7%17.6%
32.6%30.4%
10.6%9.1%
Leverage 1.69 1.30 1.83Leverage 1.691.67
1.301.28
1.831.65
ROE 30.0%29.3%
42.3%38.9%
19.5%15.0%
Source: Annual Reports 1 SEK = 0.107 €
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
p
1 US$ = 0.65 €
Vertical Integration
Manufacturing Design Distribution Retailing
ZaraWorld Co.
H&MH&M The Gap
Benetton MMango
• H&M does not own factories but has production offices next to the main suppliersmain suppliers.
• Benetton subcontracts labor-intensive activities but has invested heavily in controlling other production activities. On the other end, y g p ,most stores are franchised
• Mango does not own the stock at the stores (same as Benetton) but d ll h d
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
does allow merchandise returns
Achieving Shorter Lead Times
Source: “Zara: Fast Fashion” HBS Case 2003.
Sh t l d ti bl i k t f hi t dShort lead times enable quick response to fashion trends
…but short lead times are (usually) achieved at a higher cost
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Selling at an Affordable Price
• If procurement costs are higher, how can a Fast Fashion retailer still sell at an “affordable price”?Fashion retailer still sell at an affordable price ?
Frequent assortment
Short lead times / Small batches
Increase visits to stores Sales increase
qchanges
Revenues increase
Two-way information flows
Better forecastsMinimize underage & overage costs
Less and smaller markdowns
(POS, store managers)
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Fast Fashion, Retailing Panacea?
• Does quick response guarantee superior performance?
World Co. Zara
Time to Market 2-5 weeks 2-5 weeks
Net margins 2% 10%
Overhead (% Revenue) 40% 20%
I F t F hi db ki i ti ?
( )Source: “Zara: Fast Fashion” HBS Case 2003.
• Is Fast Fashion a groundbreaking innovation?Debatable, but for sure it is a self-reinforcing system based on:1) closed loop communications1) closed loop communications2) rapid timing and synchronicity3) appropriate capital investments to increase supply chain flexibility
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Fast Fashion Open Questions
• Is Fast Fashion a retailing fad? Remember Benetton?Benetton?
• Should every retailer adopt the Fast Fashion b i d l?business model?
• Zara-H&M rivalry. What is the right balance y gbetween basic and fashion items?
• How much can a Fast Fashion grow?• How much can a Fast Fashion grow?Mature marketWill it work in the U.S. and China?Are the operations scalable?
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Presentation Outline
• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?
• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions
• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization
• Conclusions
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Inventory Management of Zara’s Retail Network
Objective Develop and measure the impact of an optimization model that supports the optimization model that supports the inventory allocation decisions in a large retail network
Timeline August 2005 June 2007
Results - 3–4% sales increase- Less stock outs
M ti di l- More time on display- Less transshipments
Deployment Used to ship all items to all stores worldwideStatus
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Zara’s Supply Chain (2006)
Supplierspp2 shipments/wk24 - 48h transit
backroom display
70% Europe30% Asia
900 Stores:45.4% Spain37.3% R. Europe
2 warehouses:Arteixo andZaragoza
10.5% America6.7% R. World
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Source: “Zara,” Columbia Business School Case, 2002. Caro and Gallien (2007)
Former Inventory Allocation Process
assortment decisionsstore inventory assortment decisions
store
store inventoryIssues:
Storei timanagers
requested shipment quantitiesinventory warehouse
• incentives• information• resources
q p qfor each reference and size
warehouse
yin stores,past sales
inventory
Warehousewarehouseallocation team
Warehouse• resources• decision rules
shipments
(a) Former Process
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
( )
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– Erkip et al (1990): correlated demand– McGavin et al (1999): impact of balancing retailer
inventories
• Salient features or Zara’s 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)
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Caro and Gallien (2007)
Proposed Allocation Process
assortment decisionsstore inventory past sales datastore managers
assortment decisions
assortment decisions
store
store inventory past sales datastore managers input
forecastingd lmanagers
requested shipment quantitiesinventory warehouse demandinventory warehouse
model
q p qfor each reference and size
warehouse
yin stores,past sales
inventory forecasts
optimization
yin stores inventory
warehouseallocation team
optimizationmodel
shipments shipments
(a) Former Process (b) New Process Envisioned
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
( ) ( )
Proposed Allocation Process
past sales datastore managers
assortment decisions
past sales datastore managers input
forecastingd l
Maximize: Global Revenues
By Changing: Shipments
demandinventory warehouse
modelBy Changing: Shipments
Subject to: InventoryAvailability
forecasts
optimization
yin stores inventory
y
optimizationmodel
shipments
(b) New Process Envisioned
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
( )
Inventory To Sales Function
Expected store salesf f th t kfor reference that week
Expected Demandpor
Max Sales Capacity
Stock of reference in store at beginning
of week
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
of week
Store Level Display Policy
• Not all combinations of sizes are displayed:– Sales vs brand perceptionSales vs. brand perception– Key to inventory distribution
S M L Keep on display
remainingsizes action
S M L Keep on displayS M L Keep on display
M L Keep on displayS M Keep on display
M Keep on displayS L Move to backroomS Move to backroom
L Move to backroomL Move to backroom
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Store Level Display Policy: Validation
Adh t M j Si Di l P liAdherence to Major Size Display Policy
45%
50%
30%
35%
40%
45%
Sto
res
15%
20%
25%
30%
Fra
ctio
n of
0%
5%
10%
F
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
DPF/DPA (%)
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Final MIP Formulation
warehouse inventory constraints
approximateinventory-to-sales
function
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Implementation
• Forecast development p
• Model development and integration with IT systemsy
• Pilot test
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Objectives
• Prove concept feasibility through actual i l t tiimplementation
fi f i f d d l f• Refine software interface and model features based on feedback from real users
• Estimate the model’s specific impact on the inventory distribution inventory distribution
How to measure improvements?
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Metrics
• Back to basics: newsvendor framework
Sales = min{ Shipments, Demand }
• Sales / Shipments (S/S):Shipments success ratio– Shipments success ratio
– Less overstock ↔ S/S closer to 1
• Sales / Demand (S/D):– Demand cover ratio– Less understock ↔ S/D closer to 1
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Distribution Performance Matrix
Highnot enough inventory
everywhere
idealsituation
Sales / Shipments=
ShipmentsS R i
Low
Success Ratio too much inventory
in low-selling stores, not enough
too much inventory
in high-selling stores
everywhere
Low High
Sales / Demand Demand Cover Ratio
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Sales / Demand = Demand Cover Ratio
Pilot Test: Estimating Demand
• Censored information: sales are observed, not demandE l• Example:– Weekly replenishments– Initial stock = 8 units– Item stocks out before next order is placed
Mon Tue Wed Thu Fri Sat Sun
day
unitsDemand
7
8≈
Mon Tue Wed Thu Fri Sat Sun
unitsD d
8
Mon Tue Wed Thu Fri Sat Sun
dayDemand
3≈
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Mon Tue Wed Thu Fri Sat Sun
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))Demand = Sales x (7/(7-DSE))
– If Sales = 0 or DSE = 7:
Demand = most recent demand (otherwise, zero)
• Finally, we aggregate demand across all stores and references
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Design• The model was only implemented at warehouse in Arteixo
• The warehouse in Zaragoza was used to validate the • The warehouse in Zaragoza was used to validate the methodology
• We collected sales and shipment data before and after the • We collected sales and shipment data, before and after the model was introduced
• The analysis is based on 10 references, 4 basics y 6 y , yfashionable (for the rest there was not enough data)
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Methodology to Asses Impact
ObjectiveEstimate the impact of the model on the distribution performance metrics
W t b th Problem
We cannot observe the counterfactual (what if the model had not been used)
SolutionControl Group +Difference-in-differences
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Slide courtesy of Shanna Rose
Pilot Test: Control Group
• For each reference in the pilot, we identify a control f i h f ll i hi i ireference using the following matching criteria:
– 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 int od ced (i e the sta ting point m st be the same) introduced (i.e. the starting point must be the same)
W t th f th 10 f i • We repeat the process for the same 10 references in Zaragoza
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Difference-in-Differences
Pilot Start Pilot EndPilot Start Pilot End
Pilot Reference PS PE
C t l R f C C
S ifi M d l P f I t
Control Reference CS CE
Specific Model Performance Impact:
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
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Example, Reference XXX/YYY/250
Metric S/SPilot Start: Pilot End:
Metric S/Sweek 33 week 46
XXX/YYY/250 (pilot) 37.4% 78.3%
XXX/YYY/800 (control) 30.1% 65.2%
Specific Model Performance Impact:
Removes anything that happened before the pilot
( ) ( )
Removes anything that happened during the pilot but is not due to the model
(78.3% - 37.4% ) - ( 65.2% - 30.1% ) = 5.8%
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
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%!
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
, y
Pilot Test: Increase in Sales
The Fast-Fashion Business Model: An Overview Based on the Zara Case 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
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Pilot Test: Additional Results
•Less returns and transshipments
•Less stock outs
•More time on display
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Full Scale Implementation: Estimated Impact
• Full scale model implementation: 1st half 2007
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Full Scale Implementation: Impact on Net Margin
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Source: Inditex Annual Reports
What’s Next… Clearance Pricing Optimization
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
What’s Next… Clearance Pricing Optimization
• Zara avoids price promotions during the regular selling season.
• New challenge: how to estimate price sensibilities?
ParametersParameters
Parameters
ParametersParameters
Parameters
Historic Data
Parameters Parameters
Predicted
Current Season
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
What’s Next… Clearance Pricing Optimization
• Optimization model: “apparent temperature is more important than the actual one”more important than the actual one
• Most relevant metric:
($)%
StockInitial
SalesClearanceenueRevMarkdown =
Valued at regular
• Current project status:
($)StockInitial Valued at regular season prices
• Current project status:Prototype implementation readyPilot test: 3 countries, 4 categories, gFirst pricing decisions are being implemented today!
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Presentation Outline
• MotivationRecent brand value dataRecent brand value dataHow fast is Fast Fashion?
• What is Fast Fashion?Business strategy/Operations strategyT F t F hi lTwo Fast Fashion examplesFast Fashion open questions
• Research Collaboration with ZaraInventory allocation modelClearance pricing optimization
• Conclusions
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro
Conclusions
• Key lessons from Academia-Industry collaborationMain obstacles: lack of data & internal barriersMain obstacles: lack of data & internal barriersNeed project champion and clear metricsInitially, expect results to confirm intuition up to 90%t a y, e pect esu ts to co tu t o up to 90%Retail is detail: behavioral aspects matter (e.g. store level dynamics), but remain focused
• High impact application of Operations ResearchDirect impact on profitsp pScalable system that enables growth
• Fast fashion is successful because it competes with(and not in spite of) operations
The Fast-Fashion Business Model: An Overview Based on the Zara Case 2008 © Felipe Caro